Transcript:
Caroline Woods:
My next guest says the odds of a fed rate hike are substantially higher than markets are pricing. Joining me now is Ben Emons, founder and CIO of Fed Watch Advisors. Ben, great to have you here.
Ben Emons:
Good to be here Caroline.
Caroline Woods:
Especially big day with Kevin Warsh just finishing up his speech at Jackson Hole. We’ll get to the market implications. But first markets pricing in roughly a 45% chance of another hike come September. Your models are pointing to a more than 70% chance. So tell us what is your model picking up that the market is missing?
Ben Emons:
So most of the fed members currently are very about inflation. And they’re trying to say we need to get inflation under control. At a speech with Kevin Warsh focus on that as well. So before the speech the probability is around 70%. It’s likely after the speech even higher, which indicates that within the fence there there’s a clear consensus now that they need to take a step of action, which likely means they will raise rates if it isn’t in September and it’s in October.
Ben Emons:
But in some near-term, rates are going to likely go a bit higher to try to push down inflation because it’s just not going in the right direction.
Caroline Woods:
Well, we’ve actually seen the market reaction is kind of muted. First we saw stocks a little bit lower. Now I’m actually looking at the S&P that’s a little bit higher. Is a rate hike bad for stocks.
Ben Emons:
I’d say no. And here’s why. In this environment where the economy is growing really well and has a lot of investment. If you put a rate hike in the system, it starts to like slow down inflation. As that happens, the economy actually gets breathing room and can actually grow a little more. But this inflation is holding spending back is holding incomes to extend back.
Ben Emons:
So I think particularly consumers retail would benefit from a rate hike simply because a rate hike puts a bit more restriction as it calls into the financial system. And that’s that sort of filters through the economy. Price starts to moderate a bit. And that’s actually a bullish backdrop for stocks even though inflation is still there. And they may have to hike again at some point.
Ben Emons:
We don’t know that. I think it’s a bullish outcome.
Caroline Woods:
So if your model is right and the fed does hike in September, what’s one area of the market you’d want to own. And what’s one area of the market for you to avoid.
Ben Emons:
So I definitely want to own consumer discretionary because those are the sectors that should benefit. You know people’s incomes are lower than their normally is really because inflation is higher than normal. So they should benefit I think. And then you see that you would like to see more spending from consumers following maybe the areas where that is not.
Ben Emons:
So let’s say then CDSs would be say staples or materials and or some of the health care sectors. But other than that, it’s actually quite broad. In fact on the economy inflation moderates. So overall it’s actually a good, good opportunity to rotate and not stay only in tech. But look at other other sectors like consumer discretionary and retail.
Caroline Woods:
Would there be a delay though, because I would think that higher interest rates would mean the consumer would be facing even higher prices if they’re looking for things like mortgages, say that type of thing. But if the ultimate goal is to bring down inflation and then prices come down, eventually they’d pay lower prices. But wouldn’t higher interest rates actually hurt the consumer unless we’re talking about savings accounts?
Ben Emons:
It could be. But the way this mechanically works in the bond market is that if the Santa Fe series about bringing inflation down and by putting rate hikes in the system that are quite predictable, long term interest rates actually decline. You know, 30 years ago, 1996, that was the case to Jackson Hole speech from Greenspan focused on price stability.
Ben Emons:
And he was very strong about that. And the ten year yield was a 7% at that time and went down to 6%. So today we’re at over 5% in the ten year. It may start to decline, though, because Gavin Warsh today two had a sort of similar tone. We cannot let inflation continue this way and a focus on bringing it down if you’re doing it in a predictable moderate rates, and if slamming the brakes with raising interest rates really quickly, then yields are likely to decline.
Ben Emons:
And that itself will be good for housing too. So eventually the housing market housing sector, I think it will be an out of play to think of. I was again, consumers are probably be going to benefit because consumer prices may start tomorrow for me.
Caroline Woods:
If investors are, the market isn’t if they’re not adequately pricing in this rate hike yet though, what happens when they do? Does that mean we’ll see the market dip to price it in beforehand.
Ben Emons:
Is mechanically maybe a little bit possible, but technically what happens is that money is also very fluctuating. No, they change day to day, including in my model. So it’s a bit more like a projection or a model idea. People are looking and saying, okay, there’s a decent chance there’s if it’s more than 50%, that’s a decent chance that the fed will move.
Ben Emons:
If there’s no surprise in their language ahead of the meeting or at the meeting, then the market will not react negatively. It will. It will actually be digested easily, so to speak, and likely will see the market getting relief rally. This is what happened in 1996 actually. And it’s I think this time the same case.
Caroline Woods:
A relief rally. But the S&P 500 is already only 1% away from all time highs. So as you think about where the market goes from here, are you bullish and how much higher can it go.
Ben Emons:
I’m definitely bullish. You know just take the earnings and investment in the economy for the fundamental reasons. There’s nothing to be really negative about. If we also deal with the Federal Reserve. That’s not going to derail that fundamental backdrop by just aggressively raising rates. But they’re doing it moderately. Then it only becomes a more bullish outcome because you’re getting growth investments good earnings with inflation moderating.
Ben Emons:
You know and I think that’s the case overall. So the S&P could easily reach 8000 or more. And I’ll be in a camp of others with gold for this video. Because of projectiles. How the economy can behave under a banner will moderate inflation. That’s a pretty good outcome.
Caroline Woods:
So if I have cash on the sidelines, am I putting it to work right now or am I waiting?
Ben Emons:
I would already put investments in the market. Currently, I would not sit on the sidelines with so much cash. There’s not any type of like major calamity happening currently. The conflict with Iran has really moderated, although they have to figure out the Strait of Hormuz and that sort of thing. It’s not really going to deter the market any longer.
Ben Emons:
The only thing that I could think of as an uncertainty, Haniff is the midterm elections, but that’s still about nine weeks away. We get the fed meeting in between. So I would be more focused on that and thinking if I don’t described it’s just scenario and the fact that’s going to morally maybe raise interest rates once or twice in the future.
Ben Emons:
It’s all very predictable. You want to put money into work today.
Caroline Woods:
And let’s talk about the areas that you’re most bullish on. Obviously you said consumer discretionary would benefit from a fed rate hike as long as are moderate rates and not anything really aggressive. What other areas of the market do you like here?
Ben Emons:
Well, I feel like much the same in technology. I think that the software sector now making a recovery, it makes a lot of sense because there was someone in this place AI is actually enhancing software. So I think that’s an opportunity still there as a lot of stocks are much more low values, particularly in price. And those in, say, the parabolic seven and I dove, you know, that have really high stock prices.
Ben Emons:
And it was a particular semiconductor companies. And then I think the financials are in a really good place. You know they got added the capital that has continued to be regulatory relief. And if an economy picks up it’s more credit is more lending. So I think that’s a good sector. Obviously consumer discretionary. And I would play on energy.
Ben Emons:
You know energy is ultimately, you know, they have benefited from the higher oil prices. These oil prices are going to decline so easily. If anything the economy grows better, oil demand and demand for energy. But the conflict itself keeps oil prices elevated. Given a lot of your profit margin to oil companies. So I’d be bullish there.
Caroline Woods:
Can you give us any specific names that you would definitely have in your portfolio in a fed hiking environment?
Ben Emons:
Well, my my top three that I also work with clients on is I like Citigroup. That’s a great bank. It’s really major recovery now finally. And I like IBM because it’s a very diversified play. And I.
Caroline Woods:
Even after earnings.
Ben Emons:
Even have earnings. So it’s a really diversified play. And I like micron as into its taking a much more better lead and really captures now more and more market share in the semi space as much as that stock as original loss. That’s an attractive opportunity. Cost is low. Multiple is like a low, low valuation stock. And I could think of Goldman Sachs as a final one, which I always like because it’s capital markets.
Ben Emons:
This is the environment. Capital markets are thriving especially I think even with a rate hike from the feds, it’s not going to derail the capital markets. You know optimism. So Goldman me out to be.
Caroline Woods:
In you’d buy all four.
Ben Emons:
Right now I have all four investors.
Caroline Woods:
But if you didn’t own them now there’s an attractive entry point.
Ben Emons:
Still an attractive entry point here. And all of these stocks.
Caroline Woods:
What happens if the fed doesn’t raise rates and inflation does tick higher or stay high.
Ben Emons:
Yeah that would that would be a little different scenario. Because then you get the feelings in the bond market is the fed is doing enough that they feel that the traders sick, but they go behind the curve. And I guess that means that the fed is just not enough. Ahead of this problem of the what is inflation could become, then?
Ben Emons:
I don’t believe that just will happen. But to your point, if the fed gets too cautious, then I do think long term interest rates will go back higher. That would then put some dampening pressure on the on the overall market. And that’s likely the case.
Caroline Woods:
And what’s the takeaway for bond investors right now. Because we have a ten year yield sitting right around 4.7%. The two year old as you said, is above 5%. I think it was 5.2 last I checked. How should those retail investors who are sitting in fixed income or contemplating, you know, adding some bond exposure? What should they be thinking about and where are the opportunities or what do they avoid?
Ben Emons:
So it’s interesting from the bond markets and the stock market, I understand the bond market is like a supermarket. There’s a lot of different things you can buy. They’re very different stocks right. So you can buy securities that are floating rates. You can buy securities that are issued by banks. You can buy treasuries. Emerging markets international. There’s all kinds of ideas I’ve been and then I run this fixed income strategy for my clients.
Ben Emons:
I keep a very diversified strategy where I have these different types of securities in there, floating rates, security preferred, which is like a bank issued security, some emerging markets and an international diversification. Corporate bonds, high quality corporate bonds, as well as some higher yielding bonds. So you take that sort of mix and you keep your interest rate sensitivity a bit lower than normal.
Ben Emons:
You can outperform indices, you can have a decent yields. And I would have had to know said municipal bonds are attractive because that’s the tax exempt opportunity just but the yields are something like around 4% tax exempt yields. That’s to me attractive a story.
Caroline Woods:
So for the everyday retail investor who still wants growth in their portfolio but also wants and diversified exposure, how much of the portfolio should be in stocks and how much should be in fixed income?
Ben Emons:
I think it’s still sort of like take all of an 80% stocks, 20% bond environment. Why? Wow, I should just ask me before this. Uncertainty about interest rates is still higher than normal. So there’s some volatility and that should be expensive. The last bit of interest did go up again. We also have to keep in mind that although the fed may be successful with future action to bring inflation down, until we actually see that that’s important for bond investors.
Ben Emons:
Secondly, the economy continues to grow. One thing that people should know is that if GDP gross domestic product goes up, so do long term interest rates. It’s a close relationship historically always been there. Conversely, if GDP declines, interest rates go down. So in a strong growth environment. So I’ve been advising my clients. You could do 8020 on the allocation.
Ben Emons:
If you like bonds you should be more assured of maturity bonds between anywhere between T-bills and say up to five years and pick the ones I mentioned just to diversify the exposure. Then I guess you could have maybe up to 40% in bonds and do the 60% in stocks.
Caroline Woods:
I do know that 8020 equals 164 equals 100. But what about cash? Any cash in the portfolio? Because the one thing with an interest rate hike is I might actually get an email from my online savings account saying your rate has been increased versus the decreases that I’ve been getting.
Ben Emons:
Well, think of cash as an asset that brings the volatility portfolio really down. Because if you put things in cash it doesn’t move in any way. Right. So that’s the can at times be as anti-Jewish if you are in certain periods. But it’s an opportunity cost much. That means, you know, sitting in cash, you get some interest on it.
Ben Emons:
But if you had invested cash in stocks, you could have had significantly more return. So you have to make a bit trade off there. Look at it more like tactical. You keep cash at times on the sidelines too. Laid out outrun.
Caroline Woods:
But now is not one of those times.
Ben Emons:
I don’t think this is the time to be in high cash allocation. And I’m thinking there like 1,020% of folio in cash. That would be high, something I always like 3 to 5%. I sort of like a buffer for whatever you need it for, or to eventually put it to work in the market, but not 20%, because this is not environment that is.
Ben Emons:
So let’s say uncertain and disastrous if you will do the whole damage. Okay.
Caroline Woods:
Okay. So just to wrap it up, what is the biggest risk to this market? What would need to happen for you to want to be in more cash? Because it doesn’t sound like it’s inflation or fed rate hike or Iran. So what’s the biggest risk?
Ben Emons:
Well, there’s one iceberg speed bump ahead of us. It’s called the midterm elections. And if you follow the prediction markets on Kelsey or bull market, there’s a there’s a decent chance that the Congress may go. But they call blue like a Democrat. What does that mean. That means that’s potentially the data center growth that we’ve had. That has been such a boost to our economy.
Ben Emons:
We slowed down quite a bit, but this has been such a political backlash building, you know, around data centers. Secondly, it could change some of the, let’s say, ideas that security demonstration has on any other taxes that they want to lower investment, foreign investment, and that will change. So that would create some uncertainty. But historically, though, even though the Congress will become Democrats, you may get some pullback in markets.
Ben Emons:
But then eventually it goes higher again because on a Democratic Congress this continues to be robust government spending, which is really important to the economy. And that will eventually drive GDP again higher. So it’s like it’s a speed bump I think ahead of us. We’ll see how it plays out. Right? I don’t know that, but I think it’s sort of like it’s a bit of the political environment.
Ben Emons:
I mean, we the only caveat that we do have a future debt ceiling is an issue which somewhere in 2027, we’ll see how that plays out.
Caroline Woods:
So we’ll have to get you back on as we get closer to that to see how the playbook change changes. All right. Or maybe not. I think it’s a great time to pivot to a rapid fire game of this so that you know how to play. Quick questions, quick answers. No hedging. Are you ready, Ben?
Ben Emons:
Yeah. I’m ready.
Caroline Woods:
All right. Here we go. Stocks are ten year treasuries.
Ben Emons:
I’m in stocks.
Caroline Woods:
U.S. stocks are international. U.S. stocks large cap or small cap?
Ben Emons:
Both can say.
Caroline Woods:
Well, I’ll give you one. Both. But if you could only choose one.
Ben Emons:
I would still go large caps. Yeah.
Caroline Woods:
High quality growth stocks. Are value stocks tied to the economy.
Ben Emons:
Value stocks tied to the economy.
Caroline Woods:
Mega cap tech or financials.
Ben Emons:
I would think financials.
Caroline Woods:
Nvidia or an equal weight S&P 500 funds.
Ben Emons:
I think a video best growth.
Caroline Woods:
Company short term or long term bonds.
Ben Emons:
Short term bonds.
Caroline Woods:
Cash or short term bonds.
Ben Emons:
Short term bonds.
Caroline Woods:
Gold or bitcoin.
Ben Emons:
I was big goes.
Caroline Woods:
By dips in stocks or take profits.
Ben Emons:
Buying a dip in stocks. Just do it. Don’t don’t get out of the market.
Caroline Woods:
Bigger threat to stocks, a fed rate hike or the ten year Treasury hitting 5%.
Ben Emons:
Daily, Treasury hitting 5%. That would derail the stock market.
Caroline Woods:
September Fed decision hike or hold.
Ben Emons:
Hike.
Caroline Woods:
By your end one rate hike or more than one.
Ben Emons:
One rate hike.
Caroline Woods:
One year from now. Inflation closer to 2% or 4%.
Ben Emons:
Likely closer to 2%.
Caroline Woods:
One year from now. Bull market or bear market.
Ben Emons:
Still bull market.
Caroline Woods:
One word to describe how you’re feeling about the market for the rest of this year.
Ben Emons:
Bullish.
Caroline Woods:
Ben Evans you played by the rules. Our viewers are going to love that. Thank you so much. Really appreciate your insights, your picks and everything else. That’s Ben Emmons, founder and CIO of Fed Watch Advisors. If you enjoyed this street talk, check out our full interview with Andrew Graham. He reveals the stocks he thinks have the most upside from here and how to know when to buy them.
