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Shed Your Fed Fears
Interest rates will rise, but that's no reason to act rashly. These tips will help you keep your head and make sound investments in a roiling market.
By Steven Goldberg, Contributing Columnist, Kiplinger.com
June 29, 2004
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In what may be the most widely telegraphed rate increase ever, the Federal Reserve is set to raise banks' short-term borrowing rate by 0.25% Wednesday.
As usual, the crucial questions for investors can't yet be answered with certainty: How high will short- and long-term rates go? Will inflation get out of hand? Will the recovery choke?
Enough evidence exists, however, to make some fair guesses. The likelihood is that the Fed will gradually raise short-term rates from their current 1% to up to 2% by the end of the year, and to perhaps 3% by mid 2005.
Given moderate inflation -- which is likely barring a big spurt in oil prices -- the Fed has the luxury of moving slowly. What's more, a year from now, the ten-year Treasury note, currently around 4.75%, probably will stay under 6%.
What to buy ... and avoid
So long-term bonds make no sense, even if interest rates rise fairly slowly. You should stick to short- and intermediate-term funds, such as Vanguard Limited Term Tax Exempt (VMLTX) and Vanguard Intermediate Term Tax Exempt (VWITX). Fidelity Floating Rate High Income (FFRHX) is designed to rise with interest rates.
In stocks, you'll want to avoid companies that depend heavily on debt markets to stay afloat -- at least to the extent that looming problems aren't already factored into their stock prices. Automakers, homebuilders, and utilities will do poorly -- although over the long-term, homebuilders will be okay.
The stock market overall has been depressed by fears of terrorism and rising oil prices. But surging corporate earnings, riding on the headwind of rising rates, should overcome those bugaboos.
What's more, many stocks, including some financials, will do just fine as rates turn up. In sum, this is no time to abandon stocks.
Stocks that will stand up
Automatic Data Processing (ADP), the giant payroll processor, keeps a ton of cash briefly before dispensing it to its clients' employees. Higher rates translate into higher earnings for the company, says Janna Sampson, co-manager of AmSouth Select Equity A (ASECX), a superb fund that unfortunately carries a 5.5% maximum sales charge.
Sampson, 47, Neil Wright, 58, and Peter Jankovskis, 40, have co-managed the fund since late 1998. For the past five years, the fund ranks in the top 4% among large-cap blend funds. What is even more impressive is that they've delivered those high returns with substantially lower volatility than the S&P 500. Wright and Sampson have posted similarly superior returns on other accounts since 1994.
The trio generally own 20 to 25 companies with stable earnings and high barriers to competition. They buy these stocks when they're selling at discounts to their historical valuations and to the market's -- and sell them when they become fully priced.
Here are a few other stocks that Sampson thinks should do well as rates rise:
Home Depot (HD) sells low-cost building materials, which should continue to sell well even as consumer borrowing costs rise. By contrast, appliance-heavy chains, such as Lowe's, will suffer.
American Power Conversion (APCC), the maker of surge protectors, will do well by holding up better than debt-heavy tech competitors.
Harley-Davidson (HDI) didn't see sales falls during the recession, and it won't likely see sales fall now. Yes, consumer-borrowing costs will rise, but a strong economy should increase demand for its iconic motorcycles.
Pitney Bowes (PBI), with a strong balance sheet, will see its business pick up as the economy continues to grow -- even with rising rates.