InvestingDaily.com

Account Information

  • My Account

    Manage all your subscriptions, update your address, email preferences and change your password.

  • Help Center

    Get answers to common service questions, ask the analyst or contact our customer service department.

  • My Stock Talk Profile

    Update your stock talk name and/or picture.



Close
FEATURED STRATEGY

How To Collect Your Share of My Million Dollar Giveaway

How To Collect Your Share of My Million Dollar GiveawayWe recently kicked off the most outrageous initiative in the history of investment research. It’s called the Income Millionaire Project. And the goal is simple: create 1,000 income millionaires. That’s a $1 billion goal! No one has ever tried it before, but that doesn’t bother me. I’m so sure you can use this program to make a million bucks… I’ll pay you $1,000 to start your journey. Go here for details.

 

The Wild Ride

By Ari Charney on December 2, 2016

Just when the inflation trade appeared to be running out of steam, OPEC’s deal to cut crude oil production gave it new life.

Within seconds of the oil-producing cartel’s announcement, bonds and utilities, which had already been in correction mode, sold off even harder. Even for income investors accustomed to periodic volatility as inflation expectations wax and wane, the past month has been a pretty wild ride.

First, there was Donald Trump’s unexpected victory, which prompted a surprised market to furiously discount the potential effects of fiscal stimulus he had proposed on the campaign trail. Then came the OPEC decision followed by the government’s announcement that the unemployment rate is now at a nine-year low.

Based on futures-trading data, Bloomberg now calculates that there’s a 100% probability that the Federal Reserve will raise rates by a quarter-point at its next meeting on Dec. 14.

To be sure, the vast majority of traders were already betting that the Fed would hike rates in December. Perhaps more remarkable is that such certitude seems to extend well into next year, with a clear majority of traders expecting the benchmark federal funds rate to be at 1.25% by the end of 2017.

Of course, that comports with the Fed’s own predictions, which called for one rate hike this year and two the next. The difference is that the typically anxious market now appears supremely confident that the Fed will be able to raise rates according to plan.

2016-12-02-Inflation TradeSource: Bloomberg

As a result, the yield on the benchmark 10-year U.S. Treasury jumped as high as 2.48%, up about 63 basis points since Election Day, though it’s backed off a bit today. Meanwhile, utility stocks, which had been trending lower since reaching all-time highs in early July, have dropped about 5.4% over that same period, compared to a 2.6% rise for the broad market.

Back to Reality

Even so, we still think the inflation trade is running ahead of reality. At the same time, it does represent a partial reversion to the mean that we’ve been expecting all year.

For most of this year, the bond market had been pricing in a very dismal outlook, with the yield on the 10-year hitting an all-time low of around 1.36% back in July. That was clearly unsustainable.

The yield on the 10-year is more or less back to where it was in the five-year period that preceded 2016, when it averaged 2.31%.

Similarly, utility valuations hit absurd levels earlier this year, with the sector’s price-to-earnings ratio (P/E) cresting at 20.4x over the summer. That’s a pretty lofty valuation for a slow-growing sector.

Now that we’re firmly in the midst of a sector correction, utility valuations are becoming much more reasonable, recently at 17.4x. The sector is back to trading at its customary discount to the broad market, whose own valuation is getting increasingly frothy, at 20.5x. And the utility sector’s current P/E isn’t that far away from its long-term average of around 15.3x.

Events, Dear Boy …

So what might we expect in the coming year?

Well, unless President-Elect Trump suddenly develops some message discipline, his off-the-cuff style will likely mean continued volatility for rate-sensitive sectors such as utilities, at least until we get a bit more clarity on his policies.

At the very least, we would expect corporate tax cuts, which could give businesses a nice boost, including utilities, even if such a move prompts the Fed to continue draining the punch bowl.

We’re less certain about the $1 trillion in infrastructure spending that has been proposed. That number makes for good marketing, but the details that have been bandied about suggest the actual result will fall far short of that. And such spending can take a few years to flow through to the economy as a whole.

For its part, the Fed is taking a wait-and-see approach with regard to the next president’s policies.

Tighten Up

But while the current environment would seem to augur well for continued monetary tightening, implicit tightening is already underway in other areas. And if such tightening weighs on economic growth, it could end up constraining the Fed.

For one, the U.S. dollar index is at its highest level since 2003. In an increasingly interconnected world, a high dollar can weigh on global trade, pinching exports as well as overseas profits for U.S. multinationals.

The Fed kicked off the dollar’s rally, and the central bank is certainly mindful of the fact that rising rates could give lift the greenback even further.

Higher energy prices, albeit from a low base, would effectively amount to another form of tightening, while also spurring inflation.

However, it remains to be seen whether the OPEC deal, which takes effect in January, has real teeth. Member nations are notorious for cheating on production quotas, with such chicanery becoming more tempting as prices rise.

And beleaguered U.S. shale producers will likely kick production into high gear as crude oil approaches $60 per barrel, thereby putting a potential ceiling on prices.

Then there’s the global stockpile of crude oil, which is about 300 million barrels above the five-year average.

Nevertheless, the OPEC agreement, which includes major non-member producers such as Russia, is a big deal. At the very least, it could bring daily global supply and demand back into balance about three to six months sooner than previously forecast, even if its effects beyond that are more muted.

Aside from keeping inflation in check, the Fed also pays close attention to jobs data.

But while the headline numbers in the employment market would suggest a fairly rosy picture, the underlying data are less reassuring.

The pace of job growth has been slackening this year, while the labor force participation rate is still hovering just above its lowest level since the late 1970s. Wage growth, though generally trending upward, remains underwhelming.

Put all these factors together and it’s far from certain that we’ll see the sort of inflation emerge that’s been fueling the market’s bets over the past month.

In the short term, however, the market can price in whatever scenario it wants. But we believe this is a buying opportunity for utility investors.


You might also enjoy…

 

R.I.P Bull Market—Here’s How To Protect Your Wealth

I hope you’ve enjoyed the phenomenal bull market of the past eight years…

Because it’s about to come to a screeching halt.

The Federal Reserve’s nearly decade-long spending spree has finally come to an end.

With no other options left at their disposal, the Fed has no other choice than to raise interest rates to keep inflation in check.

And that leaves you with two options…

Do nothing and suffer the agony of watching the profits you’ve accumulated over the years evaporate right before your eyes…

Or reposition your portfolio and invest in companies which prosper as inflation rises and interest rates soar.

I think the choice is clear. And I’ll show you the best new positions you can take if you click here.

Stock Talk — Post a comment Comment Guidelines

Our Stock Talk section is reserved for productive dialogue pertaining to the content and portfolio recommendations of this service. We reserve the right to remove any comments we feel do not benefit other readers. If you have a general investment comment not related to this article, please post to our Stock Talk page. If you have a personal question about your subscription or need technical help, please contact our customer service team. And if you have any success stories to share with our analysts, they’re always happy to hear them. Note that we may use your kind words in our promotional materials. Thank you.

You must be logged in to post to Stock Talk OR create an account.

Create a new Investing Daily account

  • - OR -

* Investing Daily will use any information you provide in a manner consistent with our Privacy Policy. Your email address is used for account verification and will remain private.