Bad News is Good News?
Understanding the Implications of Federal Reserve Rate Cuts and Recession Strategies
Most analysts expect the Federal Reserve will lower interest rates by 0.25% at the end of July. The Federal Reserve only lowers interest rates when it wants to increase inflation, or it is concerned about slowing economic growth in the U.S. and around the world. Lowering interest rates is essentially bad news because it suggests the Federal Reserve sees economic weakness ahead.
The stock market views the bad news as good news. When interest rates decrease it acts like a primer for people and businesses to borrow and spend money. This is because the interest paid on borrowed money is less, so it costs the consumers less to borrow money. Borrowing and spending money to the stock market is just like cocaine to a drug addict. It provides a quick fix, but the long-term problems still exist.
I stated in a recent Market Update three things that have proceeded every recession:
1. INVERTED YIELD CURVE
The yield curve has been inverted since March 2019. The Federal Reserve may also be trying to correct the inverted yield curve by lowering short-term interest rates.
2. LOW UNEMPLOYMENT
The U.S. is at historic lows levels of unemployment and this has occurred prior to previous recessions.
3. A PEAK IN INTEREST RATES
If the Feds lower interest rates, this will cause a peak to occur.
Another source of interesting data provided by The Federal Reserve Bank of New York shows what they call “The probability of a Recession Index.” When the index has reached .30 historically a recession has occurred. They are projecting the index to be at 32.87% by June 2020, which means possible recession in the next twelve months. This may be another reason the Feds will lower interest rates at the end of July.
I expect the stock market will move a little higher with a cut in interest rates, but we think there is an elevated risk in the stock market over the next few months. This is based on the data we follow and monitor. It is difficult to predict when a recession will occur, but it is important to follow data from the past to understand the stock market in the future. Timing a recession is difficult because it is like driving a car while looking in the rear-view mirror at data from the past.
Strategies for a Recession
During a recession there are assets that perform better than other assets.
1. CASH
During recessionary times cash is king. It remains constant and holds its value.
2. UTILITIES
People still need electricity during recession periods and utilities pay dividends.
3. CONSUMER STAPLES
Regardless of the economic situation, people still need personal healthcare items and everyday staples to live.
4. BONDS.
Money moves from stocks to safer assets like bonds driving the price higher. In addition, as interest rates drop bond prices increase.
5. DIVIDEND STOCKS.
The dividend received from a stock can help offset the decline in the stock price; therefore, helping to reduce the overall decline of the stock.
