How the Federal Reserve is Reacting to the Current Market

Bryan Perry

A former Wall Street financial advisor with three decades' experience, Bryan Perry focuses his efforts on high-yield income investing and quick-hitting options plays.
Federal Reserve Building

The upcoming Federal Open Market Committee (FOMC) meeting scheduled for March 17-18 should be a lively discussion among the voting member Fed governors. There is no doubt those who want to remove the “patient” phrase from policy language are pointing to the recent strength in job growth. And then there’s the camp that will argue that lagging retail sales and many other soft data points aren’t just a victim of winter weather.

With gross domestic product (GDP) growth contracting, it would behoove the Fed to maintain its current policy statement and let the first-quarter numbers better determine whether a hike in the Fed funds rate is warranted in the middle of the year. While employment data undeniably has improved, wages are not going up, and inflation as measured on an annual basis is barely 1.0% — well below the Fed’s 2.0% target rate.

Another major benchmark for the Fed to consider is profit growth for corporate America and what raising the cost of credit would do to an already wounded second-quarter outlook for bottom-line growth. The consensus among Wall Street chief investment officers is that profit growth for the S&P 500, as measured by the SPDR S&P ETF (SPY), will shrink in 2015 from $132 to $199 per share. The diminished prospects for solid earnings growth broadsided six growth-sensitive sectors earlier this week, while countercyclical groups did not fare much better.

The stock market endured a day-long sell-off on Tuesday, with the S&P 500 falling 1.7% to slide below its 50-day moving average. The benchmark index surrendered its Q1 gain and is now down 0.7% since the end of 2014. The Dow dropped 1.9% as multinationals that make up the Dow index are feeling the brunt of a decade-high spike in the dollar. The greenback strength sent the euro into the 1.07 area while the Dollar Index extended its March gain to 5.2%.

The continued greenback strength also puts pressure on overseas entities that conduct their dealings in dollars. As a result, a wave of recent downward earnings revisions has lowered 2015 earnings per share (EPS) growth expectations to just 1.1% from 9.8% on Dec. 1, according to S&P Capital IQ. Additionally, if the Fed does lean to the prospect of raising rates, the dollar will only strengthen more, further exacerbating the current quandary for global markets.

To sum up the combination of the mighty move up for the dollar, the sharp downward revisions for future profit growth and the absence of commodity inflation, I am of the view that the Fed will stay the course of playing the “data dependent” card once again and not roil the markets any more amid an already highly volatile landscape. With the 10-year T-note sitting at 2.1%, the best action for the Fed is to do nothing.

No other sector reflects the current angst more strikingly than financial stocks. That sector stands to benefit from higher rates and a strong economy. Yet, financial stocks are struggling to get in gear, posting a decline of 1.8% so far this year while underperforming the broader market. The financial sector bears close watching as a gauge of the market’s thinking about the timing and impact of a rate hike. It should arguably do better if the market is comfortable with the idea that the FOMC will be raising the Fed funds rate at the right time and for the right reasons.

Taking a view from 20,000 feet above the Earth indicates that that U.S. equity markets will be range-bound for the balance of the second quarter, with upside bias still intact. However, the market will be stuck in neutral until there is more clarity on the impact of currencies and how well companies are managing the foreign exchange risk. As a result, I don’t see the Fed in any hurry to take investors to any sort of “tipping point” scenario. The rapid decline in investor sentiment, as measured by the weekly American Association of Individual Investors (AAII) survey, would suggest that many feel like we are already there.

Most certainly, the March 17-18 FOMC meeting will define the investing backdrop for the balance of March with first-quarter earnings season just around the corner. The high level of uncertainty argues well for maintaining a strong weighting in reliable dividend-paying assets in which dependable income in a herky-jerky market calms the nerves and keeps one’s capital hard at work.

Cash flow can be infectious, and when it’s in the form of monthly income, it can become habit forming. For income investors who want some portion of their assets in fixed income, taking a position in the PIMCO Dynamic Credit Income Fund (PCI) might be a great fit in the current market. It was Bill Gross’s largest personal holding among the PIMCO funds prior to his departure to Janus Funds.

This closed-end fund invests in distressed corporate debt across many sectors and global markets. The current yield of 9.1% is supported by a bond portfolio where 99% of the holdings have maturities inside 10 years, 63% inside four years. Credit quality is just below investment grade, hence the 9.1% yield, and the fund utilizes zero leverage. So the monthly payments are 100% supported by interest income.

While the stock market has round-tripped its 2015 gains with the S&P now negative for the year as of last week, shares of PCI have posted a 2% gain year to date when including dividends. In this market, grinding out 1.0% per month may sound like a turtle’s pace, but we all know how the story ends when it comes to the race to create wealth.

In case you missed it, I encourage you to read my e-letter column from last week about how to interpret conflicting data. I also invite you to comment in the space provided below.

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