Alchanati Campbell & Associates
What's up Fed Rate Cuts?
Dear Reader,Love. The feeling you can never get enough of. Or for some, a feeling they have never learned to accept. A feeling of mixed emotion. A subject of individualism and an outcome of hard-work or of fantasy or of pure luck. A diamond that you wish you had when you don’t have it, but a pebble that you have when you don’t have a fear of losing it. It’s simple: the knowing that a pair would dedicate their whole selves to the mutual fulfillment and obligation of making each other happy, important, and safe. A word thrown around, beaten up, varying in its strength of meaning. But what is love? Love has a picturesque image of roses and hearts. It’s a symbol of nurture and of commitment. It’s a feeling one can uncontrollably describe. It’s a secret one can whisper into the ear of another... “tell me what love is. That sweet hers and his. How does it feel? Is it for real? Tell me what your heart says. I’d really like to know what love is.”
The Market. Some research says that when short-term rates are higher than long-term rates for a full quarter, a recession will occur in 12-18 months. To get ready for one, clean out your portfolio (rebalance, reallocate, take profits), pay down debt, be ready to buy when stock prices plunge, and check and clean up your credit score. Q2 GDP was estimated at 2.1%. Many economists say the Fed is acting prudently to prolong the economic expansion. Their two main goals are to keep the job market strong and maintain inflation around 2%. People are taking out personal loans (APR 10.6%) to pay off credit cards (APR 17.1%). Following ESG criteria doesn’t destroy value but rather creates value. The labor market remains strong and job gains have been solid. The Fed cut rates because they see economic weakening and they want to ward it off. Interest rates and inflation have an inverse relationship: lower rates equal higher inflation.
The Fed cuts. Fed Chair, Jerome Powell, cut the fed funds rate earlier this week by 25 bps, decreasing it to a range of 2%- 2.25% The board attributed this cut to weak global growth, trade politics, and muted inflation. Although economic numbers came in as expected, or better than expected, the board decided a mid-cycle rate cut would be best to contribute to being proactive. Powell made it evident that we were entering a new regime where we would look towards trade talks, and other global indicators, as they were influencing economic numbers, to decide what the next steps will be. Our current core inflation, which is inflation minus food and energy prices, has been steady at 1.6%, expected to increase to their target of 2% in 2020. We have seen domestic inflation pressures muted, while the global world is experiencing disinflation. Wages are rising slightly, but not enough to materially affect upwards pressure on inflation. Markets stayed flat for the day until Powell mentioned the possibility that this could be followed by future interest rate hikes, which led to the market closing down 1%. On that point, Powell mentioned this was a mid-cycle rate cut, which has historically been followed by rate hikes, and that the economy could continue into an expansion.
The benefits of low interest rates. Low interest rates encourage spending, reduce the cost of borrowing, lower the cost of monthly mortgage payments, encourage investing, and reduce the cost of capital. With more spending, it increases employment and increases wages. Low interest rates reduce the discount rate used in calculating the intrinsic value of companies, which raises the valuation of companies. Low interest rates incentivize investors to take on more risky investments which means a possibility of higher returns.
Mortgages. For the vast majority of Americans, a house is likely to be their biggest investment. Mortgages are low interest, long-term secured loans. The typical mortgage works like this: you are looking to buy a house, so you secure a $100,000 mortgage and pay a down payment of 20% which brings the total cost of the home to $120,000. This loan will likely last for 30 years at the current interest rate of 3.92%. With this loan, you will pay $473 a month which adds up to $170,213 after 30 years, but since a mortgage is secured by your house, if at any time you become delinquent and the bank forecloses, they have the right to kick you out and sell your house. Mortgage rates are highly influenced by the market and have averaged 6.25% over the last 30 years. The Fed has worked to keep these rates low in order to allow the economy to keep its momentum, with the current rates around 3.75%. This is well below the average and should be leading to a rise in home sales and home refinances, but due to rising home costs, sales are down 2% from last year, home investments have declined for the last six straight quarters, and new home sales continue to decline. Just like any market, the housing market is cyclical.
The case of a strong dollar. With a strong USD, U.S. consumers pay less for imports and foreign consumers pay for more U.S. exports (hurting U.S. production and employment). A strong USD also makes the US a less affordable travel destination but benefits US citizens traveling abroad. The reason the USD is so strong is that we are considered to have a “healthy” economy compared to the rest of the world. Factors that impact currency: the strength of the economy, geopolitics, trade, inflation, and interest rates. For US consumers, it is relatively good. For US manufacturers and producers selling abroad, relatively bad.
Store-front focused retail companies. Department stores have been suffering in a self-explanatory way. In a way that you, as an American consumer, can figure out. When was the last time you spent more than an hour at the mall? When was the last time you shopped in a store-front department store? The issue at-hand for department stores in e-commerce. If department stores don’t have a competitive advantage in this new market, they are doomed to fail. And this basic thesis explains my position of betting against department stores (ex: Macy’s and Nordstrom). Both Macy’s and Nordstrom state that a major risk they face is from the competition in the digital space. In the short-term, tariffs and political affairs abroad have been hurting these companies. Nordstrom’s biggest challenges are being competitive in the e-commerce market (current digital sales are 30% of total sales), consistently growing their return on assets (2015 ROA: 8.1%, 2019 ROA: 7.07%), lowering their debt-to-equity levels, and improving their liquidity. Nordstrom has been outperforming their comparables due to “Nordstrom Racks”, their discounted retailer. This allows them to sell to a diversified demographic, gain more sales, and increase their inventory turnover. Macy’s has seen three years of consecutive declines in sales, decreases in the amounts of stores they own, a decrease in inventory turnover, and a decrease in cash flow per share. Conclusion: e-commerce is dominating the retail industry and department stores must innovate or be crushed.
The Alchanati Campbell and Associates Team
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