For at least several decades, Wall Street has been obsessed with the actions of the Federal Reserve. Market followers with shorter memories are at least aware of the Fed’s extraordinarily accommodative monetary policy in the six years since the 2008/2009 financial crisis. This policy has been effective and has helped the US economy fare much better than that of other developed economies during this period.
Since it became apparent that the Fed would end its quantitative easing policy and subsequently consider when it would be appropriate to start raising interest rates, there has been considerable investor angst about how the market might react as we return to a more normal interest rate environment. Those that write about the markets have also tackled this topic quite frequently. It seems hardly a day goes by that there is not an article available on the internet speculating about when the Fed will start raising rates.
The latest bit of economic data often causes the market to gyrate (either up or down). Many appear to believe that higher rates will be bad for the market. This creates an environment where the market tends to fall on good economic news and rally when economic data is less favorable. The conclusion is that “bad” news could encourage the Fed to maintain its “zero interest rate policy” (ZIRP) for longer. On the other hand, “good” news leads to the view that an interest rate hike will happen sooner.
Interest rates matter to investors. Historically, when interest rates start to rise market returns have been positive as the Fed typically starts to increase rates because of economic strength. Higher rates cause the fair market value of the principal of long-term bonds to fall as rates rise. Over time, interest rate increases can depress corporate profits and reduce the likelihood that companies will invest to expand their operations.
At BWFA, we look to avoid the hysteria associated with the release of the latest economic data. We are more interested in the longer term trends. As it relates to interest rates, we are more concerned with understanding how the general level of interest rates may change over a period of years, rather than this week, this month or even this year. We endeavor to understand what our companies are doing to prepare for a higher rate environment. Our decision-making process is not based on the Fed’s daily actions or its most recent pronouncements. We think there are better ways to spend our time than watching the Fed’s every move.
Our investment process is based on identifying well-managed companies that we believe can deliver long-term value to client portfolios. Trying to predict the Fed’s next action runs contrary to our investment approach.