The 'Gravity' of Finance Is Setting Up an Opportunity Today
Editor's note: Now is not the time to bail on the bull market...
The Federal Reserve approved its first rate cut since March 2020 in September. And we've seen a lot of headlines questioning what this pivot from a high-interest-rate environment means for stocks.
According to Retirement Millionaire editor Dr. David "Doc" Eifrig, the coming changes to the Fed's rate-hike strategy is setting up a lucrative opportunity for investors.
In today's Masters Series, adapted from the October 18 issue of our free DailyWealth e-letter, Doc details how you can position yourself to profit from this recent shift...
The 'Gravity' of Finance Is Setting Up an Opportunity Today
Finance and economics have a problem with "physics envy."
I grew up to see science as the noble pursuit of the world's ultimate truths...
I'll always love the process of using evidence to make conclusions and predictions. I have little patience for guesses or hunches. I want to pursue truth when I write... whether it's about health or wealth.
The hard sciences pursue deep, immutable truths like gravity, quantified in specific mathematical expressions. That's what a lot of folks want in the markets, too.
But economics and finance don't work like that... other than in one aspect I call the "gravity" of finance.
We can model its effects with scientific precision. And it's the key driver of asset prices and investment performance... no matter the market environment.
I'm talking about interest rates.
Every asset's value is pegged to interest rates. Yet, for a time, no one paid them much attention.
After the 2008 financial crisis, the Federal Reserve kept rates at record lows. Borrowing money cost little, and squirrelling away cash provided minimal returns.
Then the pandemic led to runaway inflation. The Fed was forced to hike rates to 40-year highs. Suddenly, interest rates were all anyone could talk about.
Higher interest rates have undoubtedly changed the financial and investing landscapes over the past few years. But now that the Fed has started its rate-cutting cycle, income investors like us could see a windfall opportunity...
In 2022, many technology stocks cratered.
The junkiest, most unprofitable tech stocks had been the best performers during the pandemic and the year that followed. But when interest rates rose, many of them fell 90% or more.
Why would higher interest rates tank technology stocks? It's simple.
First, these kinds of tech stocks made no profits. That means investors weren't pricing them based on their current earnings. They were pricing them based on potential future earnings (in some cases, the distant future).
Since we know cash in the future is worth less than cash today, a stock that won't bring in cash until the future is also worth less when interest rates rise. It's the "time value" of money applied to future earnings.
Investors started calling unprofitable growth stocks and biotechs "high-duration equities." ("Duration" is a finance term used for bonds with long maturities and a high sensitivity to interest rates.)
At the same time, interest rates influence stocks through their fundamentals...
Unprofitable growth companies require capital. Interest rates reflect the price of capital. If a company needs to pay more for debt or equity financing, that reduces whatever profit margins it might have.
So when interest rates rose in 2022, the tech-heavy Nasdaq Composite Index collapsed. But it was much worse for the unprofitable tech darlings than it was for the big, profitable cash-flow creators.
It might seem obvious... but many people don't understand why the stocks of profitable companies would outperform those of unprofitable ones.
This logic extends as you move toward more profitable, conservative stocks – like the stocks we hold in my Income Intelligence newsletter.
Stocks that favor current profits over future ones will be less sensitive to rising rates... And stocks with less debt will be less sensitive than those with heavy debt loads.
You'll also see a difference between stocks in cyclical sectors versus those with a more defensive tilt. But this difference is harder to parse.
Take, for instance, an oil company. Oil stocks go through booms and busts based on demand. They benefit from high oil prices, which tend to accompany a strong economy.
When the Fed raises interest rates, it slows the economy. However, in many cases, the Fed only raises rates because the economy is growing too briskly.
When looking at a cyclical stock, you must understand the balance here...
Rising rates may hurt cyclical stocks if inflation threatens and the economy isn't strong enough to withstand higher prices. However, if the economy is strong enough, that could benefit the company more than the penalty of rising rates.
Altogether, as rates head lower, it should broadly benefit conservative, income-generating stocks. These companies aren't flashy... They're simply able to focus on making money in the present.
To clarify, though, we only want to hold stocks with close ties to falling rates... not stocks that will only do well on lower interest rates.
Humility is our partner here. The effects of interest rates may be the gravity of finance – but no formula will tell you exactly what interest rates will be at a given time.
The good news is, with the Fed's latest actions, we have a better understanding than ever before of how rates may drive our portfolios in the coming year. And that's all we need.
We can't time interest rates perfectly. But we can predict how they'll impact our investments... and choose to collect assets that will treat us well in any future path.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Editor's note: One subscriber learned Doc's strategy so well that he has earned around $118,000 in extra income since he started using it... regardless of what news has been dominating headlines.
And Doc just went on camera with him to reveal how you can adopt this method to build yourself a steady flow of income – without touching stocks or bonds. Learn more here...