The Fed Tipped Its Hand – What You Need To Know
Dear Wealth Watch Reader,
Are interest rates headed higher or not? One crowd says “yes”, the other “not yet.”
Turns out, the Fed just tipped its hand and gave us the answer.
Below, what it means for you and your investment strategy.
The Bond Market Minefield and the Income Opportunity Zone
What’s your portfolio worth today?
Or more importantly, what will your portfolio be worth by the end of the year?
The answer is going to be largely determined by who wins the bond market tug of war.
If you haven’t noticed, interest rates have been on a steady climb since December. The 10-year yield is within a whisper of 3% and is now sitting at a four-year high, according to Bloomberg.
The $64,000 question is whether interest rates are headed higher or not.
Don’t ask the worthless Wall Street crowd.
Roughly half of the 59 analysts in a recent Bloomberg survey predict that the 10-year yield will end 2018 at or below 3%. The other half — big surprise, eh? — expect it to be at 3% or higher.
The most important party to listen to, however, is the Federal Reserve. They actually control short-term interest rates.
The Fed Tips Its Hand
The Fed’s own projections call for interest rates to climb above 3% before settling back to 2.75% by 2020.
Source: U.S. News
2020 is a long way away. But the Fed tipped its hand when it released the minutes for its Jan. 30–31 FOMC meeting. At that meeting, the Fed kept interest rates steady in a range of 1.25–1.5% but continued their warning about intended future rate increases.
Previously, the Fed stated the improving economy would warrant “gradual increases,” but their newest January statement notes economic improvements would warrant “further gradual increases.”
What this means is the Federal Reserve is getting more hawkish than ever. In the released minutes:
“A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate.”
Remember, the Federal Reserve raised rates three times in 2017 and signaled that it expected to raise rates three more times this year because of the improving economy.
No wonder interest rates are rising.
Income investors sitting on a pile of bonds, bond funds or bond ETFs should be very worried.
In fact, if you own a lot of long-term bonds, you can expect your portfolio to be worth a lot less by the end of this year.
The Wrong Way, the Right Way
In the old days, you could buy a bunch of bonds, clip coupons and retire fat and happy.
But the three-decade-long bull market in bonds is OVER.
And if you don’t want your income-focused portfolio to get hammered, you need to change the way you invest your money.
In simple terms, bonds are the wrong way and dividend-paying stocks are the right way.
One of the main reasons that the Federal Reserve is more positive about the economy is the positive effects of the Trump tax cuts.
“The effects of recently enacted tax changes — while still uncertain — might be somewhat larger in the near term than previously thought,” Fed minutes revealed.
Sure, America is deeply divided over President Trump’s politics.
But Corporate America is licking their chops over tax cuts, which reduce the top corporate tax rate from 35% to 21%.
It is yet to be determined where and how Corporate America will spend those tax savings, but one place they are already showing up is in the form of dividend increases.
A CNBC Fed Survey found that 36% of economists and fund managers expect the tax savings to be used to buy back shares (22%) and pay out dividends (14%).
In fact, two companies just upped their dividend payouts and specifically cited the Trump tax cuts as the reason.
Last week we shined the spotlight on Clorox (NYSE: CLX) as a prime example.
The company recently announced an increase in its quarterly dividend by 14% and attributed the increase to the tax cuts.
CEO Benno Dorer notes, “We’ve been looking forward to putting tax reform benefits to work, with an emphasis on supporting long-term business growth and rewarding our shareholders. We’re very pleased to accelerate our dividend announcement, which reflects a 14% increase in our quarterly dividend.”
Source: Clorox Press Release
Ryder System (NYSE: R) is another great dividend payer taking advantage of the new tax cuts. The transport and supply chain management company recently increased its dividend by $0.06, to $0.52, a 13% increase.
A recent company press release notes:
“This dividend increase is due to the ongoing earnings benefit expected from the Tax Cuts and Jobs Act.”
And you better believe many more of these tax savings and dividend payout increases are on their way.
A new IHS Markit survey is now forecasting that global dividends will increase by 10% in 2018.
A new record!
The bottom line is that income-focussed investors have the choice of getting slaughtered in the bond market…
Or they can enjoy a rising stream of dividend checks from companies thriving in the improving economy.
Here’s to growing your wealth,
Chief Income Expert, Mike Burnick’s Wealth Watch
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