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How a Fed halt could hurt you
(Page 2) of 2
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No one with an existing fixed-rate mortgage needs to worry -- unless they're looking to move up to a new home and need a new mortgage. But any increase in long-term interest rates will gradually take a bite out of the cash flow of anyone with an adjustable-rate mortgage.
Hard assets and financial stocks will rally
Investors aren't just looking at the end of a period of rising short-term interest rates; they're looking at the end of a period of extreme predictability. Month in, meeting out, we knew what the Fed was going to do -- raise short-term rates by another 0.25 percentage points. We knew inflation was going to stay under control, at least officially.
Whatever comes next has to be less certain than that. Already, hard-asset, safe-haven stocks that profit from gold, copper, timber and oil have moved up in 2006 on just the suspicion of future inflation. Gold closed at $541.20 an ounce on Friday, up 4.6% for the week. It's up 30% since the end of 2003.
Financial stocks will do well, not because they're safe havens in times of uncertainty, but because the end of the Fed's policy of raising rates will take the pressure off their profit margins. Banks borrow short -- from depositors or in the short-term commercial paper markets -- and lend long. They make their profits out of the spread between short-term and long-term rates. The collapse of the spread between short-term and long-term interest rates has cut into those profits. The end of short-term rate hikes alone will help financial companies and their stocks because no longer will the spread get smaller and smaller from month to month. A widening of the spread would be gravy for the sector, but it's not necessary for the sector to outperform in 2006.
The Fed may need to cut rates
The financial markets have come to rely on the godlike powers of the chairman of the Federal Reserve. 
Alan Greenspan
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With a tweak here and a polysyllable there, Alan Greenspan can tame inflation, goose growth, strengthen the dollar and -- after changing in the nearest phone booth -- fix liquidity crises with a single flood of cash. Or so the markets have come to believe.
The historical record, however, suggests that the Federal Reserve usually overshoots. It raises rates too much, and the economy starts to show signs of stalling. Or it cuts rates too much, and the financial markets show signs of an asset bubble. The odds, after what is likely to be 15 interest-rate hikes over almost two years, are that the Fed will overshoot in 2006, as well. As Bill Gross, the bond guru of Pacific Investment Management notes in his most recent newsletter, the Federal Reserve often has to cut rates within six months of ending a series of interest-rate increases.
No guarantees, of course. But this is exactly the kind of unexpected turn of events that consumers, mortgage-holders and investors ought to expect.
In my next column: my first three picks for 2006.
New developments on past columns
"Do-nothing Fed is dangerously disengaged": Everybody jumps to attention when a company that has been showing slowing growth shifts back into growth mode. That's what has happened at General Cable (BGC, news, msgs). After averaging negative earnings growth for the last five years, the company in 2005 began what Wall Street analysts project as a five-year period of almost 17% annual earnings growth. No wonder the stock is up 30% since I added it to Jubak's Picks on Sept. 9, 2005. But at this point in the growth cycle, I'm actually just as impressed with the improvements to General Cable's balance sheet. Thanks to free cash flow that investment house Stifel Nicolaus estimates at $8 to $9 a share for 2006-2009, General Cable has made three moves recently to improve its balance sheet. In October, the company completed an interest-rate swap that reduced borrowing costs by 2 percentage points on $150 million in fixed-rate debt. In November, General Cable began an offer to holders of its convertible preferred shares to turn those shares into common stock. And later that same month, the company renegotiated its revolving credit line to increase the credit line and to reduce the interest rate on the line by about 0.75 percentage points. This should eventually result in an upgrade to the company's credit rating and a climb in the stock's multiple. Right now, General Cable is trading at just 15 times projected 2006 earnings per share. As of Jan. 10, 2006, I'm raising my target price on General Cable to $24 a share by May 2006 from the prior $21 by March 2006.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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