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.