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April 25th, 2023
Careful What You Wish
As we get closer to the May FOMC meeting where the Fed is likely to increase interest rates by another 0.25 basis points, it sparked a conversation around the Traders Reserve office about what happens when the Fed finally pivots.
Would a Fed pivot be a good thing?
The Fed ultimately decides that economic conditions are stable enough to reduce interest rates. This is done to incentivize borrowers to consume and invest more quickly. After all, what can you do when interest rates are near 0%? It forces corporations and consumers to allocate their funds differently since there’s no advantage to having cash sit in accounts with low-interest rates.
The problem is that data suggests the stock market doesn’t react well when the Fed cuts interest rates.
Because they are usually reacting to what the economic conditions are telling them, so they tend to cut rates to spur economic growth. That typically means growth is slow and unemployment is high at the time the Fed is looking to decrease rates. And that usually indicates a period when stocks don’t perform as well.
While there may be a short-term boost with each announcement of a rate cut, it turns out that the market performance tends to fall as more time passes following the announcement.
The performance of the S&P 500 fell by approximately 10% one year after each of the 29 Fed rate cuts from 1994 to March 2020.
So, we need to be careful about what we wish for.
But it’s not all bad news. Some sectors benefit from rate cuts. The steeper the cut, the more impact it has on consumer credit, mortgages, car loans, and credit cards. Meaning companies with automotive and home building or home buying may be the ones you start looking for when the Fed starts to cut rates.
If the market sells off and can’t move with earnings beats, I’m looking to be bearish on the real estate sector. So today I’m adding the BlackRock Real Estate ETF (IYR) to my list of bearish candidates for future spread trades.
I think the banking mess is far from over, and should we enter a recession, we could see real estate go into a correction. I’m not saying it will crash, but economic conditions aren’t favoring a rush on real estate and IYR only offers a 2% dividend. There are better options out there if you’re looking for dividends within the real estate sector.
IYR has been flat since the beginning of April, so I want to see it break out of its channel before making a move.
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Editor, Filthy Rich Dirt Poor
Coach, Options Testing Lab
Any trade or trade idea discussed is for educational purposes only. They will not be tracked as an official trade recommendation.
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