What ‘Tighter Monetary Policy’ Means and What Investors Should Do About It


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IIf you’ve been paying attention the past few days, I’m sure you know the Fed will conclude its regular meeting today, after which it will issue a statement, and President Jay Powell will give a press conference. Almost every economist, analyst and Fed watchers thinks these things will matter this time around. The central bank should move away from its view that inflation is transient and signal a shift towards tighter monetary policy. However, if you are relatively new to investing and / or are not consumed with it every day, you are probably nodding your head at it, but deep in your mind are two questions: What does “a policy really mean?” tighter monetary policy ”and, more importantly, what does this mean for my investments?

A tighter monetary policy will be achieved by doing two things. The first is to reduce the amount of asset purchases the Fed is currently making. Since the middle of last year, the Fed has bought more than $ 100 billion worth of treasury bills and mortgage-backed securities from banks each month and does so with the money they essentially create there. end. This was their response to the economic chaos caused by the pandemic, and it has two effects.

The first is to provide liquidity to banks, which means that they have plenty of liquidity to lend to individuals and businesses or with which to buy stocks or make other investments. This promotes growth and supports the stock market. The second is that it keeps interest rates on longer-term bonds low. The Fed sets short-term paper rates, but long-term rates are set by the market. By buying massive amounts of 20- and 30-year securities to maturity, the Fed drives up the prices of these longer-term bonds and, in the upside-down world of bonds, higher prices equate to lower yields or rates.

Powell is expected to announce that the Fed will drastically reduce the amount of its regular purchases and chart a way forward to eliminate them, while giving some idea of ​​when and how big the rate hike will be to tackle the now persistent inflation. . .

So if banks are going to have less money to invest in stocks and economic growth is going to be deliberately slowed down by rising rates, the answer to the question of what this means for your portfolio would seem like a “disaster.” “, is not it ?

Well, not necessarily.

First, drastic changes to a long-term portfolio are hardly ever a good idea. It’s usually best to just go through the ups and downs. Moreover, none of this will surprise the market. This has been expected for some time, therefore, assuming there isn’t a drastic acceleration in the planned schedule of three quarter-percent rate hikes each starting in the middle of next year. , a large part is probably already integrated in the actions, even if we are not far from the peaks.

So now is not the time to take drastic action in a long-term portfolio, but there are a few adjustments investors should consider.

First, think about why this is happening. This is because of inflation, so it makes sense to look to stocks of companies that have strong pricing power. An example could be Apple (AAPL), where customers have consistently been price insensitive. If inflation persists, commodity producers will also benefit. Energy and materials companies won’t see big increases in their costs, but will receive more money for every barrel of oil or tonne of metal they produce. They are a good place to hide for a while if the Fed does as expected, although slower growth will hurt demand somewhat.

At the same time, holdings in companies that will face rising input costs but where customers are very price sensitive should be reduced if they are not sold upfront. That would bring in consumer discretionary stocks such as parent company Coach and Kate Spade, Tapestry (TPR) and other luxury goods companies as well as most automakers, for example.

Another area where adjustments should be made is anything that derives a large portion of its value from dividends or other regular payments. If bonds offer higher interest payments, the relative value of other performance-based investments will fall, so items like utilities and REITS will be less valuable on a relative basis.

Even though we all think we know what Jay Powell is going to say today, there could be a pretty dramatic reaction when he actually says it, especially if there is something in his words that hints at faster adjustments. than expected from the policy. So it’s important that investors get started with a plan today. Having one keeps you from being panicked by short term volatility and taking actions that make little sense in the long term and preventing you from making bad decisions is an essential part of a successful long term investment. Tighter monetary policy is coming, and after a long period of historically lax policy, this can come as a shock, expected or not. However, if you understand what this really means and make some minor adjustments to your portfolio based on that knowledge, you should be able to overcome it and focus on your long term goals.

Want more articles and reviews like this? If you know Martin’s work, you’ll know that he brings a unique perspective to the markets and actionable ideas based on that perspective. In addition to writing here, Martin also writes a free newsletter with in-depth analysis and business ideas focused on a single, long-standing underperforming industry that’s rebounding quickly. To find out more and subscribe to the free newsletter, click here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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