Investment markets have been schizophrenic in recent days, and that alone should be a serious red flag. After falling 2% last Friday, the S&P 500 rebounded on Monday, only to give back those gains and then some.
At the epicenter of the volatility is the “will she, won’t she” game played by U.S. Federal Reserve Chair Janet Yellen. Current sentiment appears to be dovish, but this could turn unexpectedly. Knowing which stocks to buy and which stocks to avoid will be critical.
For now, Wall Street is banking on an accommodative policy. According to futures market pricing, the likelihood of the Federal Reserve raising interest rates — which could come as early as next week — dropped to 22% from 30%. Comments made by key central bankers reaffirm those odds.
In addition, I have recently argued that the economy can’t handle a substantive hike in interest rates. Over the long term, economic growth has dwindled, while average unemployment rates have actually risen.
Despite the bullish evidence, forecasting isn’t a perfect science — hence the term “probability.” I’m not suggesting that Janet Yellen will pull out a Jack Del Rio moment. What I am saying is that should the Fed move forward with an unpopular rate hike, it wouldn’t be totally baseless.
Nearer-term data is favorable for a more hawkish strategy. And we all know that Republican presidential candidate Donald Trump is no fan of low interest rates, doubling down on his criticism of Yellen.
Much like the political race, fear and uncertainty are ruling the markets. Nevertheless, investors should be ready to adapt their investments on a moment’s notice. Here are two stocks to buy — and two stocks to avoid — if indeed the Federal Reserve turns off the monetary spigot.
Stocks to Buy After an Interest Rate Hike: Sony Corp (ADR) (SNE)
There’s no denying that Sony Corp. (ADR) (NYSE:SNE) — and Japan, Inc. as a whole — will likely have to endure multiple rebuilding seasons. That’s the price to pay for a protracted deflationary cycle that just won’t go away. At the same time, bearish headwinds can produce discounted value plays, and SNE stock is a prime example.
When Prime Minister Shinzo Abe first took over the reins in Japan, he promised an economic recovery, later dubbed “Abenomics.” The sudden drop in the yen’s value made Japanese companies no-brainer stocks to buy.
But the trend’s reversal earlier this year turned them into stocks to avoid. Should interest rates move higher, that will likely strengthen the U.S. dollar, providing another spark for Abenomics.
Click to Enlarge While yen valuation isn’t the only lever for SNE, it certainly doesn’t hurt. The increased purchasing power of American consumers will give them more leeway into discretionary spending.
Although it’s still hurting from bad business breaks, SNE is blessed with a diverse product lineup. If the Federal Reserve is right about the economy, the positive data is coming right before the holiday season.
That’s a major boost for SNE, which has already pulled together an impressive performance in the markets this year despite tough odds.
Stocks to Buy After an Interest Rate Hike: Nestle SA (ADR) (NSRGY)
It’s no secret that European markets have been stunted over the trailing two-year period. That’s when the U.S. dollar soared to multiyear record highs. Even the Swiss markets have been on a broadly downward slide, limiting gains for the country’s top companies.
But Nestle SA (ADR) (OTCMKTS:NSRGY) has bucked the trend this year, moving to a 7% gain. If the Federal Reserve decides to raise interest rates, I’m looking for NSRGY to build on its momentum.
As with SNE, some residual benefit from a likely stronger dollar should swing towards NSRGY. Generally speaking, if the Federal Reserve believes in America, the best value plays will be somewhere else. Foreign companies are great stocks to buy as investors rotate out of bloated, domestic blue chips. Furthermore, Nestle operates in a secular industry. No matter what, people need to eat.
Better yet, customer behavior patterns play into Nestle’s hands. According to Giorgio Caputo of First Eagle Investment Management, increased wealth tends to increase purchases of processed foods. It’s a pattern noticed among emerging markets, where NSRGY takes in nearly half of its revenue.
NSRGY is well-positioned, both through strategy and through fortuitousness, making it one of the best stocks to buy.
Stocks to Avoid After an Interest Rate Hike: William Lyon Homes (WLH)
There are a lot of opportunities that will be created should interest rates rise. But what the Federal Reserve giveth, the Federal Reserve taketh away.
In other words, there will be plenty of stocks to avoid.
According to “Economics 101,” a rate hike would incentivize saving, as long-term borrowing costs would increase. That’s going to send a chill down the spine of companies which have benefitted from historically low interest rates. For that reason, William Lyon Homes (NYSE:WLH) is on my warning list.
I’m not picking on WLH stock, per say. You can look at a number of companies directly exposed to real estate and state a bearish argument. But my strongest case against WLH comes from evidence compiled by the Federal Reserve.
Real estate bulls may point to new family homes sold, which numbered an impressive 654,000 units in July of this year. That’s a 24% improvement since January. But with interest rates so ridiculously low, shouldn’t that rally be stronger?
Click to Enlarge If you think I’m expecting too much, consider this: average new homes sold from 1963 through 2009 is nearly 675,000 units. In this decade, though, the average is only 419,000 units. Obviously, those are figures that are inclusive of the pain from the Great Recession. But even if we were to base our policy on last July’s sales haul, it’s still below long-term averages. That means the lift in WLH may come to a painful stop for unsuspecting investors.
Even with the low interest rates, WLH is actually negative for the year. That immediately qualifies it as one of the stocks to avoid.
Stocks to Avoid After an Interest Rate Hike: BofI Holding, Inc. (BOFI)
It’s time for a reality check. If interest rates rise, banking shares will be the prime stocks to avoid. And “bro banks” like BofI Holding, Inc. (NASDAQ:BOFI) may be at greater shareholder risk.
If established banking institutions are seeing their summer rally stymied by the Fed’s drama, how will a young bank headquartered in a “bro city” like San Diego fare? Judging by the litany of poor reviews on Yelp, BOFI is potentially staring at big troubles.
The commonly cited aphorism is that interest rates are good for banks like BOFI because of the increased margins. Thus, they should be considered stocks to buy. Ordinarily, I would agree with that argument. However, as with real estate, the low rates have spurred economic activity, but not to a high enough degree.
Click to Enlarge The idea behind quantitative easing was to inspire confidence — and money velocity — in a frightened economy. Afterwards, the diet can be imposed.
The problem is that the economy is far from stable — if it was, why the heated debate? And the money generated from activities incentivized by dovish policies will surely tap out. In addition, higher rates would increase the banking sector’s expense on servicing their own debts. If that’s a challenge the big banks must manage carefully, it’ll be even more critical for a bro bank like BOFI.
I’m of the opinion that Janet Yellen will not raise rates. But if she does, BOFI will definitely be one of the stocks to avoid.
As of this writing, Josh Enomoto was long SNE stock.