As was widely expected, the Federal Reserve kept rates unchanged at the end of its two-day policy meeting. Instead, it shifted its focus to unwinding its massive balance sheet which currently amounts to $4.5 trillion. The central bank indicated that the process of offloading the bond holdings it had built up in the years immediately after the Great Recession will begin in September.
Such a move also amounts to monetary tightening of another kind. But markets have chosen to focus on the Fed’s move to recognize that inflation has remained low, belying its earlier expectations. This development has given rise to speculation that another rate hike may not occur this year after all. Given such a scenario, investing in stocks benefiting from a soft interest rate environment may continue to be a prudent option.
Focus Shifts to Balance Sheet Trim
With the Fed staying away from a rate hike at the end of its meeting, the spotlight is now squarely on the unwinding of the central bank’s massive balance sheet. The language of the Fed’s statement indicates that it will begin this process around September.
The massive $4.5 trillion balance sheet consists of Treasury securities worth around $2.46 trillion and $1.77 trillion of mortgage backed securities. Most of these securities were accumulated as part of the Troubled Asset Relief Program (TARP) in the years following the recession of 2008.
Initially, the Fed plans to offload securities worth $10 billion a month which will increase within a quarter to $50 billion. Even after this cycle is completed, Fed officials project that the balance sheet will still be larger than $2 trillion. The Fed Chair and other key officials have repeatedly indicated that this process should not disrupt market activity. However, concerns that poor demand for such bonds could result in an increase in rates continue to linger.
Inflation Concerns Take Center Stage
But such concerns have been overshadowed by the Fed’s change in stance on inflation. The central bank’s statement dropped the word “somewhat” from its June statement instead choosing to directly state that inflation continues to remain under 2%. This only represents a slight shift but is significant because it acknowledges a negative perception about one of the Fed’s key objectives.
Data released earlier has already raised such concerns on several occasions. Currently, average hourly wage growth refuses to rise above 2.5%. Meanwhile, the Price Consumption Expenditures index or PCE, also referred to as the Fed’s preferred inflation gauge, remains at 1.4%. What is noteworthy is that the labor market continues to improve, and unemployment has declined to 4.4%.
This is why investors have rightly chosen to focus on the Fed’s change in tone on inflation. There is a growing feeling that the Fed will not raise its rates in the near future. Following the release of the policy statement, the CME Group’s FedWatch Tool declined from 52% to 50%. This means that markets now believe that the likelihood of the Fed raising rates after its December meeting has declined.
The Fed’s acknowledgement that inflation has failed to rise to its targeted levels has captured the attention of market watchers. Investors now believe that such concerns will hinder the Fed’s central bank’s attempts to raise rates in the near future.
This is why investing in stocks from the utilities, telecom and real estate sectors looks prudent at this time. However, picking winning stocks may be difficult.
This is where our VGM score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM score.
We have narrowed down our search to the following stocks based on a good Zacks Rank and VGM score.
KB Home (KBH - Free Report) is a well-known homebuilder in the U.S. and one of the largest in California.
KB Home has a VGM Score of A. The company has expected earnings growth of 51.7% for the current year. Its earnings estimate for the current year has improved by 5.8% over the last 30 days. The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
PulteGroup Inc. (PHM - Free Report) engages in the homebuilding and financial services businesses primarily in the U.S.
PulteGroup has a Zacks Rank #2 (Buy) and a VGM Score of A. The company has expected earnings growth of 32.9% for the current year. Its earnings estimate for the current year has improved by 0.4% over the last 60 days.
The AES Corporation (AES - Free Report) is a global power company based in Arlington, Virginia.
AES Corp has a Zacks Rank #2 and a VGM Score of A. The company has expected earnings growth of 7.1% for the current year. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 10.63, lower than the industry average of 19.27.
Eversource Energy (ES - Free Report) engages in the energy delivery business.
Eversource has a Zacks Rank #2 and a VGM Score of B. The company has expected earnings growth of 6.8% for the current year. Its earnings estimate for the current year has improved by 0.2% over the last 30 days.
Cincinnati Bell Inc. (CBB - Free Report) is a full-service regional provider of data and voice communications services over wireline and wireless networks, a full-service provider of data center colocation and related managed services.
Cincinnati Bell has a Zacks Rank #2 and a VGM Score of B. The company has expected earnings growth of 9.1% for the current year.
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