Fed Chairman Jerome Powell handled his first Federal Open Market Committee (FOMC) meeting like a real pro.
The newly elected head of the Federal Reserve projected a calm, informed and experienced voice at his first press conference discussing the FOMC’s policy decision, and he also orchestrated unanimity among the FOMC’s members. While he made a good first impression, time and future actions may change that perspective.
The unanimous vote to raise the Fed Funds Rate by 25 basis points from 1.50% to 1.75% wasn’t a surprise. One related issue that drew my attention, though, was the fact that the Fed’s inflation forecasts were barely changed despite the median estimate for the unemployment rate in 2019 (3.6%) and 2020 (3.6%) being nearly a full percentage point below the Fed’s long-term forecast of 4.5%.
At first glance, this would imply rising wage inflation and tighter Fed policy. Powell stated that he was surprised wage growth hasn’t been stronger given the low unemployment rate and indicated that the Fed will know the labor market is getting tight when there is stronger wage growth.
However, the median estimate for PCE inflation in 2019 (2.0%) was unchanged from December, while the median estimate for PCE inflation in 2020 (2.1%) edged up by only 0.1 percentage points. The assumption here is that while full employment is possible, efficiency and the quality of the jobs being filled won’t spark wage inflation pressures. Powell was quick to point out that these median estimates are moving targets with an array of variables that can change their outlook and policy directives.
Basically, the major takeaway for investors this time around was that the median estimate for 2018 continued to point to an expectation of three rate hikes this year, and not four as some had feared. Also, investors should pay attention to the slightly higher median interest rate projections for 2019 and 2020 (from 2.7% to 2.9% and from 3.1% to 3.4%, respectively).
Mr. Powell quickly tempered any undue concern about those changes when he calmly reminded everyone that all forecasts are subject to change based on the evolution of the economy. The path of interest rate hikes could be a little less gradual or a little more gradual based on how future economic conditions unfold. This response might seem a bit evasive at first, but it is actually a sound response.
Addressing trade and tariffs, Powell said a number of members brought up the tariff, but that there was no consensus that changes in trade policy would have any effect on the current outlook, at least not for the present. At this stage, Mr. Powell added, tariffs were only identified as a low-profile risk that had the potential to become more prominent.
Given how intense the reaction has been to a potential trade war and how this scenario could envelope sentiment in the weeks ahead, investors should anticipate a gradual pace of increases in the Fed Funds Rate. This way, the Fed is making sure it doesn’t do too much, too soon, to choke off expansion or damage consumer confidence, which the economy is so dependent on.
While Powell gave a solid performance and the markets narrowly dodged the bullet of a fourth rate hike for 2018, markets still sold off this week, fueled by investor anxiety about trade wars and the data breach at Facebook, among other factors.
This week, House and Senate leaders posted a bill to fund the government through Sept. 30 of this year. The $1.3 trillion spending plan includes significant boosts to U.S. military spending, which was supported by President Trump and congressional Republicans. Meanwhile, Democrats succeeded in securing boosts to domestic spending that most Republicans opposed.
Congressional leaders lauded the legislation publicly while working behind the scenes to convince skeptics to back the legislation. House Speaker Paul Ryan joined other Republicans in highlighting the military spending increases that included the biggest increase in defense funding in 15 years.
The legislation begins to reverse the damage of the last decade and allows us to create a 21st-century fighting force, Ryan said.
Add to this the appointment of John Bolton, a hawk on military, as the National Security Advisor last week, and you have a very bullish scenario shaping up for defense stocks.
One the big beneficiaries of this wave of new spending will be Northrop Grumman (NOC), one of the five largest aerospace/defense companies in the United States. The stock has been performing like a champion for the past year and hit an all-time high of $359.43 at the end of February. With last week’s market sell-off, shares of NOC traded down to $340 with a rising 50-day moving average at $336. The John Bolton headline caused the stock to rise from this level.
This past week, in my Instant Income Trader advisory service, I recommended a bull-call-spread on Northrop Grumman. One of the great things about this service is that you can buy thousands of dollars of shares for big-name stocks like NOC for comparatively little. In this case, I recommended the NOC November16, 2018 $330 Calls at $38.50. Since one options contract equals 100 shares of the underlying stock, we effectively purchased $33,000 of NOC stock for $3,850. How nice is that?
As an additional part of this trade, I recommended the out-of-the-money NOC May 18 $375 Calls for $7.00. If the stock trades back higher again, the NOC May 18 $375 Calls will be executed and called away, meaning the seller of the NOC $375 calls is obligated to deliver 100 shares of stock for every contract sold at $375 per share.
If this is the case, then the NOC $330 Calls my subscribers hold will be converted to stock and delivered accordingly. Despite paying $38.50 for these options, the delivery of NOC shares at $375 means Instant Income subscribers can exit the trade with a capital gain of $6.50 per share profit ($375 – $330 = $45; $45 – $38.50 = $6.50). Plus, if we add the $7.00 from the NOC May $375 Calls, we get a total gain of $13.50 ($6.50 + $7.00 = $13.50).
Dividing the $13.50 gain into the $38.50 cost basis of the NOC Nov. $330 Calls means our net gain on the trade is 35.00%. And that’s if the stock only appreciates by just 5-6%. In other words, it’s possible to make several times the return you would have by simply holding the stock for a short time, and at a fraction of the cost. That’s how to trade the big-name stocks without tying up a lot of capital!
To find out more about how we put these intelligent trades to work in stocks like Northrup Grumman, MasterCard, Lockheed Martin, Boeing, Apple and more, I invite you to click here and discover how bull-call spreads can spice up portfolio performance using the crème-de-la-crème blue-chip stocks that are leading the bull market higher.