BRACKET BUSTER: Janet Yellen Just Pulled the Biggest March Upset
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If you paid attention to the talking heads this week, you would think the sky is falling…
Classic talking heads….
Sure, stocks have been in a steady decline since March 15th. But if you look at the ticker tape you’ll realize that this “under siege” market has only sustained a paltry 2% dip in the S&P.
Today I’m going to show you why you shouldn’t be worried by what these boo bears are saying. And… why, even in the face of the Fed’s march towards higher interest rates, there’s an easy way to stay ahead.
The Root Of Market Madness
On March 15th, Janet Yellen and the Federal Open Market Committee raised interest rates.
The Fed’s new target for short-term interest rates is 0.75–1.00%, higher than at any time since the financial crisis.
Along with the interest rate hike announcement, Janet Yellen made it clear that the Fed intends to continue hiking interest rates throughout the year.
Of course, with the current target set at or below 1%, the war on savers still rages. Retirees and savers who rely on interest payments to cover life expenses are still under severe pressure. And that’s not going to change anytime soon…
If you’re currently covering your life expenses from savings — or if you expect to retire anytime soon — you need to find new sources of income besides Treasury bonds and savings accounts. Hopefully, you’re already taking advantage of opportunities and locking in your share of healthy dividends.
And that begs the question… What happens to dividend stocks as interest rates rise?
Interest Rates and Stocks: Not What You’d Expect
If you listen to the talking heads on CNBC or some other news channel, you’ve probably heard some big warnings recently. These pundits have been quick to tell investors about how dangerous it is to hold stocks when interest rates are rising.
Let me explain the logic they use — and then show you why their argument doesn’t hold water…
Most of the financial media believe that higher interest rates will send stocks lower. Their argument is that higher interest rates will make it more difficult for companies to borrow money for growth opportunities.
Without borrowing this money — or because of the higher interest expenses — corporate profits will not grow as fast. And with less profit growth, stocks will trade lower as investors become disappointed.
That’s why these traditionalists think markets are about to fall.
It makes sense if you look at only the higher interest rates that companies pay. But there’s much more going on in the economy right now.
Two Reasons the Market Will Continue Higher
Think about the fact that our economy is already growing and new jobs are being created. Those new jobs are leading to more families having discretionary funds that they can spend. More spending helps to boost profits — which in turn leads to more jobs.
Right now, we’re in an expansionary phase of the economy. And that’s the only reason the Fed can raise rates! (If the economy were stalling, the Fed would certainly not hike interest rates.)
Also, keep in mind that the Fed is set to raise interest rates at the same time that new tax reforms are being debated in Congress. If the Republicans are able to pass tax legislation that reduces corporate tax rates, companies will be able to generate higher profits because of lower tax expenses.
So even though interest expenses may be higher, tax expenses will be lower. This helps to offset the effect of higher interest rates and leaves companies in a stronger position.
Investors will take all of these factors into account:
- Higher interest rates
- Strengthening economic growth
- Lower corporate taxes.
And when looking at the strength of the total environment (not just the higher interest rates), stocks could continue to trade higher.
One Lingering Concern, and How to Protect Your Wealth
Now, even though I don’t think a rate hike (or series of rate hikes) spells imminent doom for the stock market or for your portfolio, there is one concern that I still have.
That’s the valuation of the overall stock market today.
When I say “valuation,” I’m talking about how much investors are paying for stocks, compared with how much income the underlying companies are generating.
Today, investors are paying a premium price — compared with earnings — to own many companies in the market.
Why are they paying a premium price?
It’s largely because investors expect earnings to grow. So investors are willing to pay more today to own a company that will earn more tomorrow. That’s the way the market works. Investors pay prices that reflect their expectations… not just what’s happening today.
As a general rule, I don’t like paying premium prices for dividend stocks. That’s why I always look for companies we can buy at a reasonable price. And I look for companies that will pay us generous dividends that have the potential to grow over time.
I frequently refer to these factors as our three pillars of income investing:
- Protect your capital
- Invest for growth
- Lock in reliable income.
And that’s why I believe this investment strategy will hold up very well — even in a rising interest rate environment.
Here’s to growing and protecting your wealth!
Editor, The Daily Edge