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Markets & Stocks > Sivy on Stocks
How to play the (almost) inverted yield curve
February 7, 2000

Interest rates look like they'll peak by May, so start buying depressed financials now. Fannie Mae is the best bet.
By Michael Sivy
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The end is in sight. The Fed began a series of interest-rate increases last summer, and it probably will act two more times, raising a quarter point in March and another quarter point in May. And that will be it.

When Alan Greenspan was nominated to a fourth term as Fed chairman in early January, I told investors to keep an eye on trading activity following Fed rate increases--if long-rates went on to fall, I wrote, that would indicate a peak was near. And that has all but happened, with the yield on the 30-year Treasury bond falling to 6.25%, more than half a percentage point below its high earlier this year.

The yield curve, which plots the yields of bonds of different maturities, isn't exactly inverted--the yield on six-month Treasury bills still is a quarter point lower than that of 30-year bonds. But two-year yields are considerably higher, at 6.6%. So a full inversion is very close, and two more Fed rate hikes should do the trick.

That's a big deal. By May, short-term interest rates will probably be high enough to slow the economy, allowing long-term rates to fall even further during the second half of the year. And by the time it's clear that rates are heading down, financial stocks, which have been most hurt during this period of rising interest rates, should be in the midst of a rebound.

So start looking at top-quality financials now, even if it may be a couple of months early. In the past, I've recommended Chase, which I still like. But as a global operation, Chase shares depend on a lot more than the actions of the Fed and bond traders. As a pure play on a turn in rates, I favor the Federal National Mortgage Association, better known as Fannie Mae.

This mortgage intermediary behaves like a gigantic savings and loan, but with a couple of key advantages. First, Fannie Mae's mortgage securities are indirectly backed by the U.S. government, giving it a superb credit rating. Second, because Fannie Mae mostly buys mortgages, bundles them into fixed-income securities and then sells them, it doesn't suffer from squeezed lending margins when short-term rates rise.

The key for Fannie Mae is housing sales, which are tied to employment (46% of its mortgages go to low- and middle-income customers), and mortgage rates. Low levels of unemployment and interest rates in the second half of the year would be near-ideal conditions for the stock.

Two-thirds of the analysts who follow Fannie Mae rate it a strong buy and they project a 14% long-term earnings growth rate (in line with the 14% gain for the most recent quarter). At $58 a share, the stock is flat with where it was two years ago. And with this year's earnings estimated at $4.25, Fannie Mae has a P/E of only 14--equal to its growth rate. You don't see prices like that very often in today's market.






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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.