What If the Fed Does Cut Rates and It's Already Totally Priced In?

Investing

Published: July 23, 2019 7:05 am

Last Updated: January 6, 2020 3:08 am

June’s massive jobs numbers were amazing, and they showed just how strong the economy may be. While most were looking for about 165,000 jobs to be added, the blow-out print of 224,000 was way off the radar for most firms, seeming to indicate that the economy is still much stronger than many anticipated.

The weak May jobs number turned out to be a red herring of sorts when the strong June figures were reported. The unemployment rate actually edged slightly higher to 3.7%, but it remains near 50-year lows.

Many were worried that the strong numbers would prevent Federal Reserve Chair Jay Powell from pulling the trigger on a 25 basis point July rate cut, but Powell all but guaranteed that a cut was in the works, when he stressed last week that the U.S. inflation outlook is near historic lows.

That has caused economists and investors see it as a certainty that the Fed will lower the key borrowing rate at the policy meeting July 30 and 31, and Powell in recent statements has moved to solidify those predictions by pointing to some concerns about economic growth both here and abroad, and as indicated, the persistent weak inflation.

With interest rates already at close to generational lows, there clearly is no imperative need to lower rates now. However, President Trump has continued to jawbone Powell, citing the policies of foreign central banks as a major reason we should cut rates.

Plus, and perhaps even more importantly, and as Powell may be well aware of, research going back to 1980 indicates that the Federal Reserve has lowered rates 17 times when the S&P 500 was within 2% of new highs. One year later? The S&P 500 was higher all 17 times.

However, the market is always forward looking, and it’s very possible that the Fed rate cut is priced in. After the market surged to new all-time highs following the Powell Humphrey-Hawkins testimony to Congress, we seem to have hit somewhat of a brick wall. With milestones like Dow 27,000 and S&P 500 3000 surpassed, it seems that some investors are using the all-time highs to sell.

Given the huge run of the market over the past 10 or so years, and the longest economic expansion in U.S. history now currently still ongoing, it makes sense that some investors, especially baby boomers hitting retirement age in record numbers, are looking to lower their overall risk profile by taking some money off the table.

One thing is for sure: passive investing via exchange-traded index funds may not be the way to go over the next couple of years. A shift to large cap value is very possible, and within that group of stocks there is a large number of incredible companies that pay good dividends.

With rates expected to stay low, large cap value could indeed be an excellent play and one good vehicle is Vanguards High Dividend Yield Fund (NYSE: VYM). It has 423 stocks and will give investors exposure to many multinational companies, such as AT&T, Verizon and Merck. Financials are the largest sector, at 18.6% of the portfolio, with consumer goods and health care coming in second and third. The fund pays a dividend that yields 3.05% quarterly, which is higher than the current 30-year U.S. Treasury bond yield.

There is probably upside left to the market, maybe to 3,200 on the S&P 500. But the lion’s share of the big money in index investing probably has been made. It makes sense to look at value, and possibly also at small and midcap companies, as the Russell 2000 has underperformed the overall market in dramatic fashion.