The Politics of Stocks, Part 5: The Federal Reserve

The final installment of our first five part series “The Politics of Stocks” In this episode, CIO Chris Perras discusses the Federal Reserve and how “The Fed” can exert a powerful effect on the stock market.

Chris: This is Chris Perras, chief investment officer Oak Harvest Financial Group. Welcome to the March 15th edition for a weekly Stock Talk Podcast, Keeping You Connected To Your Money. This week episode is titled The Politics of Stocks, The Part Five, The Federal Reserve. After earnings, the federal reserve is probably the most important component or factor that politics affect in the stock market.

The chairman of the federal reserve is nominated by the acting president of the United States. The chairman serves a four-year term. The chairman is the acting executive officer of the entire central bank in the United States. Congress established the federal reserve’s three key objectives. Those being, to maximize employment, two, to stabilize pricing and inflation, and three, moderating long-term interest rates.

More recently, the federal reserve’s duties have expanded to include regulating banks, maintaining a stable financial system, and providing economic research to the financial community. For a moment, reflect on how important and big those responsibilities are. Think about how many ways the federal reserve can change or affect the investing world with their policies.

Think how many ways the federal reserve can change or affect the three components of stock market return. They can affect earnings by way of their policies, they can affect PEs and valuations easily through their policies. They can affect the company’s ability or mainly their desire to pay dividends as well. The federal reserve controls how difficult or easy it is to get credit.

They set short-term interest rates, which affects the banking system’s ability or desire to lend money versus holding money as deposits. This in turn helps accelerate or decelerate overall economic activity. In turn, this changes most companies’ marginal return on invested capital. Companies that have very fast growth, only marginally affected because their core secular growth can outweigh any small change in interest rates that the federal reserve may place on them.

However, a large part of the stock market in our economy, has slow economic growth and small changes in federal reserve policy can have large marginal changes on earnings, investor sentiment, and growth, or it also can have a big effect on valuations. Group-wise, utility stocks, they’re are boring stable highly regulated industry. They love low interest rates because it’s a low-growth industry.

Cyclical stocks like Caterpillar and Deere, love an environment where the federal reserve is easy and interest rates are stable because the companies that purchase their equipment can better predict their return on capital investment over long periods of time. Consumer stocks do better when credit to buy goods and services is easier to come by and the ability to finance large purchases like cars and homes is easier to make.

There’s a reason. The simplest rule and the number one rule of macro investing is don’t fight the fed. They have that much power over the economy. They have a much greater influence over the economy than any individual political policy can. Prime example is the period 2017 through December 2018, just recent, the last two years.

In 2017, the federal reserve was on hold, the Trump tax plan was merely an idea, stock market volatility was very low and stocks soared to S&P 500 2875 into late 2018. Then, the federal reserve started raising rates to slow the economy. The S&P 500 dropped almost 12% in a month. The Trump tax plan was passed and the S&P 500 then rose to 2940 into September of 2018.

All the while the federal reserve was continuing to raise rates, trying to slow the economy and inflation. In October 2018, the federal reserve came out and said, “We are far from being done raising rates,” and over the next 10 weeks, the S&P 500 dropped 20%, erasing not only the Trump tax gains but also the gains all the way back to the beginning of 2017. I will repeat, don’t fight the fed.

I hope you enjoy our five-part series on The Politics of Stocks. The whole series can be found on our website at oakharvestsfg.com. This podcast focusing on the federal reserve is a great intro into next week’s podcast, which I’m going to entitle as Yogi Berra said, “it’s deja vu all over again.” This is Chris Perras, chief investment officer at Oak Harvest Financial Group, thanking you for listening, and many blessings.

Speaker 2: Content contained within this Oak Harvest podcast for informational purposes only, and is based upon information current as of the time of recording. It should not be considered an offer or solicitation to buy or sell securities, nor is it tax or legal advice. Investments involve risk. Unless otherwise stated, particular investment returns are not guaranteed.