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Fed Moved Decisively

The Fed Moved Decisively – Week in Review

The Fed Moved Decisively

The Fed moved decisively and increased the Federal Funds rate by 0.5% this past week, the highest increase since 2000, after a 0.25% increase at the last meeting. The US Federal Reserve will also reduce its balance sheet starting June 1st. The Fed holds about $9 trillion of mortgage-backed securities (MBS) and US Treasuries. Specifically, on May 4th, the Fed stated,

Although overall economic activity edged down in the first quarter, household spending and business fixed investment remained strong. Job gains have been robust in recent months, and the unemployment rate has declined substantially. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.

The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the US economy are highly uncertain.

The invasion and related events are creating additional upward pressure on inflation and are likely to weigh on economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.

…the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee decided to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities on June 1st, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet…

Fed Moved Decisively
The Fed Moved Decisively

The Consequence of the Fed’s Actions

Since the Fed moved decisively, there was immediate consequences. First, there was a relief rally because some expected a 0.75% increase. However, the following day, downward pressure on the stock market resumed, and it had the worst day since 2020.

Next, interest rates for longer-dated US Treasury bonds increased. The 5-year, 7-year, 10-year, 20-year, and 30-year bonds pay 3%+. Notably, the 20-year bond is closing in at 3.5%.

US Treasuries Interest Rates
Source: US Treasury

Third, the Fed will be reducing about $35 billion in US Treasuries and $17.5 in MBS per month from its balance sheet starting June 1st. This action will increase to $60 billion and $35 billion, respectively, in three months. This action will put upward pressure on interest rates and mortgage rates, benefitting some companies and penalizing others.

Stock Valuations are Down

Stock valuations are down significantly from the end of last year. The latest S&P 500 Index reading is a price-to-earnings (P/E) ratio of ~20.8X based on trailing twelve months (TTM) earnings. This multiple is the lowest since 2019. Simultaneously, yields have increased for many stocks approaching levels last seen during the bear market of the early pandemic. As a result, it is possible to buy Dividend KingsDividend Aristocrats, and Dividend Champions at a 4%+ dividend yield.

The P/E ratio (TTM) captures the market decline, but it does not capture the relatively good earnings reported by most businesses in 2022. The combination of declining stock prices and excellent earnings is reducing the P/E ratio (FWD). The S&P 500 Index’s valuation is about 17.4X, a reasonable one on a forward earnings basis.

Buffet is Buying

One investor is seemingly OK buying equities when others are selling, Warren Buffett. We addressed that Buffett was buying and active in the stock market a few weeks ago. According to his annual letter, he had about $144 billion on his balance sheet at the end of 2021 and deployed nearly $50 billion since then. However, to summarize, he has bought:

  • Commons share of Occidental Petroleum (OXY)
  • All of Allegheny Insurance (Y)
  • Commons shares of Hewlett-Packard (HPQ)
  • Commons share of Activision Blizzard (ATVI) as an arbitrage play.

Final Thoughts About the Fed Moved Decisively

So, what does this mean for the average retail investors who do not have Buffett’s billions? Furthermore, they are more fearful than he is, as shown by the elevated CBOE VIX reading of over 30X.

Inflation will probably reduce as the Fed remains hawkish and will make moves to suppress it. However, the headwinds of high oil and natural gas prices, rising COVID cases in China impacting supply chains, and the conflict in Ukraine will keep upward pressure on inflation. Consequently, there may be downward pressure on stocks.

Despite this trend, according to Morningstar, some sectors and investing styles are undervalued. So it may be time to buy for the daring, but you should still expect greater market volatility. However, it is important to stay invested.


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The Stock of the Week

Today we highlight BlackRock (BLK), the exchange-traded fund (ETF) fund giant. BlackRock is the largest provider of ETFs in the world, ahead of Vanguard. The firm is one of the few asset managers with consistent net inflows due to the strength of its ETF offerings. BlackRock had over $9.5 trillion in assets under management (AUM) at the end of Q1 2022. According to Stock Rover*, the stock price is down about (-30.9%) year-to-date (YTD). Simultaneously, the dividend yield went up to 3.1%, and earnings well covered it with a ~42% payout ratio. The stock’s P/E ratio is down, its other valuation metrics are in the lower half of its 5-year range, and the stock price is below the 150-day moving average, as seen in the chart below.

BLK Valuation Metrics
Source: Stock Rover*

Dividend Increases and Reinstatements

Search for a stock in the list of dividend increases and reinstatements. This list is updated weekly. In addition, you can search for your stocks by company name, ticker, and date.

Dividend Cuts and Suspensions List

The dividend cuts and suspensions list was most recently updated at the end of April 2022. As a result, the number of companies on the list has risen to 551. Thus, well over 10% of companies that pay dividends have cut or suspended them since the start of the COVID-19 pandemic. The list is updated monthly.

Three new additions indicate companies are experiencing solid profits and cash flow in April.

The new additions were Gouverneur Bancorp (GOVB), Bridge Investment Group (BRDG), and Western Asset Management (WMC).

Market Indices

05/07/22

Dow Jones Industrial Averages (DJIA): 32,899 (-0.24%)

NASDAQ: 12,145 (-1.54%)

S&P 500: 4,123 (-0.21%)

Market Valuation

The S&P 500 is trading at a price-to-earnings ratio of 20.84X, and the Schiller P/E Ratio is about 32.46X. These multiples are based on trailing twelve months (TTM) earnings.

Note that the long-term means of these two ratios are 16.0X and 16.9X, respectively. 

The market is still overvalued despite the recent market correction and rebound. Earnings multiples more than 30X are overvalued based on historical data.

S&P 500 PE Ratio History

SP500 PE Ratio
Source: multpl.com

Shiller PE Ratio History

Shiller PE Ratio
Source: multpl.com

Stock Market Volatility – CBOE VIX

This past week, the CBOE VIX measuring volatility was down about 3.2 points to 30.19. The long-term average is approximately 19 to 20. The CBOE VIX measures the stock market’s expectation of volatility based on S&P 500 index options. It is commonly referred to as the fear index.

CBOE VIX
Source: Google

Yield Curve

The two yield curves shown here are the 10-year US Treasury Bond minus the 3-month US Treasury Bill from the NY York Fed and the 10-year US Treasury Bond minus the 2-year US Treasury Bond from the St. Louis Fed.

Inversion of the yield curve has been increasingly viewed as a leading indicator of recessions about two to six quarters ahead, according to the NY Fed. The higher the spread between the two interest rates, the higher the probability of a recession.

10-Year Bond minus 3-Month Bill
Source: NY Fed
Spread Between 2-Year and 10-year US Treasuries
Source: St. Louis Fed

Economic News

The US Bureau of Labor Statistics Job Openings and Labor Turnover Survey, JOLTS reported a record 11.5 million job openings as of the last day of March, 205,000 more than in February. In addition, the number of job openings has topped 10M for eight consecutive months. Before February 2020, the highest reading was 7.7M. Industries contributing to the increase include retail trade (+155,000) and durable goods manufacturing (+50,000). Offsetting the increase were decreases in openings for transportation, warehousing, and utilities (-69,000), state and local government education (-43,000), and federal government (-20,000).

The US Bureau of Labor Statistics reported that 428,000 jobs were added in April, as the unemployment rate stayed at 3.6%, with 5.9M unemployed. February 2020’s pre-pandemic reading was 3.5%, with 5.7M unemployed. Payrolls were revised for February (-36,000) and March (-3,000). The April increase in payrolls was broad, with the biggest gains concentrated in leisure and hospitality (+78K), manufacturing (+55K), and transportation and warehousing (+52K). Employment in professional and business services and retail trade is tracking above pre-pandemic levels, while leisure, hospitality, and manufacturing are still below pre-pandemic levels. Average hourly earnings increased 0.3% in April and followed a 0.4% reading in March. At $31.85, average hourly earnings are up 5.5% from a year ago, compared to an inflation rate of 8.2%.

Thanks for reading The Fed Moved Decisively – Week in Review!


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