The Market Hasn’t A Clue About the Effects of a Rate Change
On September 17 at 2:00 PM Eastern Time the Federal Reserve Board released its much anticipated Federal Open Market Committee report, and… NOTHING! For days the financial news coverage focused on whether the Fed would raise interest rates by a measly 0.25% off zero or not change interest rates. The Fed chose to keep its target fed funds rate at zero percent, where it has resided since December 2008, almost seven years ago.
The reaction in the stock market was pure comedy. After the announcement, market indexes surged upward, with the Dow Jones Industrial Average climbing by almost 150 points. Then as Fed Chairman Janet Yellen held her press conference, the market decided that the rates were not changed for the wrong reasons –whatever the right and wrong ones are– and the indexes declined to close in negative territory for the day. From the 2:00 PM press release until the 4:00 PM market close, the DJIA went through a 300 point swing. All on the news that nothing was changing!
Here is the one day chart of the S&P 500 for September 17. View and wonder:
The point is that after seven years of zero percent short term rates and over 10 years since the last time the Fed announced a rate increase, the stock market has no idea what will be the actual effects of higher interest rates. Everything is driven by a fear of the unknown. However, in this case fearing a 0.25% or even a 0.50% interest rate hike is like being afraid of a buzzy gnat. The market appears to have no memory or an understanding that in the days before the financial crisis and resulting recession, interest rates were well above zero percent and the Fed changed rates on a regular basis. To get a historical perspective, the following charts show the fed funds rate and the S&P 500 starting 20 years ago in 1995 through the end of 2007, when the financial crisis started to take down the markets.
The reality is that the Fed will soon start to increase interest rates and will ramp up at a very slow pace. Above zero percent interest rates, possibly in the 1% to 3% range will not materially affect the ongoing business operations of most companies. Corporations may see a modest increase in borrowing costs, but it will take several years for those costs to work their way into income statements, providing ample time for management teams to adjust to a different rate environment. Remember that markets can move very rapidly, but the economy and business results move at a much slower, deliberate pace.
This type of market price action and reaction reinforces my belief that a yield and dividend growth focused approach to stock investing is one of the better strategies for long term positive and above-average investment results. For example, Blackstone Mortgage Trust (NYSE:BXMT), a finance REIT, just announced a 19% increase in its dividend rate. That announcement has propelled the BXMT share price to a nice 4.7% increase in just the first week after the news release. Blackstone has increased the dividend rate by 38% over the past two years, yet the stock is priced to yield over 8%. Ownership of this type of stock allows me to just watch and laugh when the market reacts as outlined above. I like the idea of collecting that big dividend payment every quarter and look forward to larger payouts in the future. If the BXMT share price drops a bunch due to market fear and stupidity, I will add more shares to my position.
With no rate change from the Fed this time around, we will go through all the noise and angst again; probably in December. My advice is to make sure the dividend stocks you own have a history and the potential for continued dividend increases, and be ready to add to you positions if prices are driven down to hard to believe low values and correspondent high yields.
Disclosure: Long BXMT