Every few months, the stock market gets obsessed with dots.
The Federal Reserve releases its “Summary of Economic Projections” report in March, June, September, and December.
It contains a chart known as the “dot plot.” Take a look:
Source: The Federal Reserve
The Fed most recently published this dot plot last week.
If you’ve never seen it before, deciphering it might feel like looking at a psychologist’s Rorschach inkblot test.
But the market knows what to look for. And it breathed a sigh of relief when it saw this dot plot.
That’s because it shows the Fed is on track to cut interest rates up to three times this year… And that was music to its ears.
Today, I’ll explain how the dot plot works. Then I’ll show you how to use it to prepare your portfolio for what’s coming next.
What Last Week’s Dot Plot Means
It used to be difficult to predict what the Fed would do next with interest rates. And when it unexpectedly raised or lowered rates, it sent shockwaves through the market.
That’s why the Fed created the dot plot in 2012.
After the Financial Crisis, interest rates were stuck at zero for years. The Fed wanted to raise rates. But it also didn’t want to spook the market…
So it started publishing the dot plot to give advanced warning of what it was likely to do next.
So, what does it show, exactly?
Each dot in the dot plot represents the opinion of one Fed official. And the position of each dot shows where that Fed official thinks interest rates will be at the end of each upcoming year.
The Fed has seven people on the Board of Governors and 12 regional bank presidents. So there can be up to 19 dots for each year.
Here’s what the latest chart shows…
- Two Fed officials think rates should stay where they are in 2024, between 5.25–5.5%.
- Two think there should be one rate cut, putting rates at 5–5.25%.
- Five think there should be two rate cuts, putting rates at 4.75–5%.
- Nine think the Fed should cut rates three times this year, bringing rates to 4.5–4.75%.
- One thinks we need four rate cuts, putting rates at 4.25–4.5%.
In other words, the Fed is pretty certain rates are going down this year… Most members think three rate cuts are going to happen.
The only question is when.
Interest rates have a big impact on the economy and stock market. They affect how much we pay on credit cards, mortgages, and auto loans. They also impact businesses borrowing money and the amount the government spends on its debts.
So having the dot plot to give a sneak peek at what the Fed is thinking is a useful tool.
Now, it’s important to remember the dot plot isn’t an official forecast. The Fed can and does change its mind based on the economic data it sees.
For example, in March 2021, the dot plot indicated the Fed thought interest rates would start rising in 2022 and 2023 but not go over 1%.
Well we all know how that turned out… Sky-high inflation forced the Fed to raise rates a lot faster than expected.
But if things go as expected, the dot plot can help investors see what the Fed is likely to do with interest rates months in advance.
Plus, the market tends to behave with the Fed’s indications in mind. So we want to position ourselves to benefit from this.
Getting Ahead of the Fed’s Indicated Actions
Right now, it’s looking likely the Fed will cut rates up to three times this year. So it’s time to start preparing.
When the Fed cuts rates, the interest you earn from the money in your bank account usually drops pretty quickly.
So while you should examine your own situation and do what’s best for your specific portfolio… One thing you can generally do is to lock in rates for longer-term certificates of deposits (CDs) or bonds.
Another option is to invest the money into sectors of the stock market that tend to do well as rates fall, such as utilities.
According to MoneyTalk, here’s what happened the last three notable times interest rates declined:
- In 2011, utilities were the best performing sector.
- In 2014, utilities were the second-best sector.
- And in 2018, they were also the second-best performing sector.
Utility companies usually pay high dividends. When interest rates drop, more investors want to buy utilities to collect their safe high yields. So now’s the time to get ahead of the crowd before prices start moving up…
One utility company I like is Essential Utilities (WTRG). It provides water service to customers in Pennsylvania, Ohio, Texas, Illinois, North Carolina, New Jersey, Indiana, and Virginia. It also owns a gas utility in Pennsylvania and Kentucky.
A couple of weeks ago, I explained how a new Environmental Protection Agency (EPA) rule will force water utilities to invest millions of dollars to upgrade their systems. That means Essential Utilities may take a hit in the short term. But these upgrades will boost the company’s earnings in the years to come.
Essential Utilities is a reliable dividend payer that has increased its payout 31 years in a row. Right now, it yields 3.4% and trades at 18x earnings.
The company’s stock has historically traded at an average of 26x earnings. That means it’s on sale at a 30% discount right now.
If interest rates fall as the dot plot predicts, intelligent income investors will want to own companies like Essential Utilities.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Intelligent Income Daily
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Source: Wide Moat Research