What to buy ahead of the Fed's rate hike

Overseas equity investors have the opportunity to consider their portfolios after the US Federal Reserve surprisingly chose to leave interest rates unchanged this month despite an improving US economy. While it was never certain that a token 25 basis point rate hike would take place, global equity markets rallied before the decision was announced and then sold off the day after.

The decision to leave rates unchanged was clear and it will have a number of implications for international investors during the rest of the year and into 2016.

In the policy statement released the Federal Open Market Committee (FOMC) stated: “recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term… The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad.”

As to the domestic US economy, the committee noted:

• “Household spending and business fixed investment have been increasing moderately"
• “The housing sector improved further," and
• “Labor market indicators show underutilization has diminished.”

In my experience, the Fed has usually confined its concern and commentary to the domestic market. The last time international economic and market developments prevented the Fed from raising rates was in 1997-1998 in the middle of three crises - the Long Term Capital Management debacle, the Asian Financial crises and the Russian default. At that time the US economy was growing at 4 per cent.

Fed keeps a closer watch on international conditions

Does that mean that global economic conditions are as dire as in those years? No, absolutely not. The risks of a severe global recession are small. What it does mean going forward? The Fed will consider conditions outside the US (read China) more closely than in the past. 

Personally I would have preferred a rate rise just to get it out of the way. A 0.25 per cent hike would not have derailed economic recovery nor driven bond yields to levels that would have created an alternative asset to equities.  

That's not to say we couldn't still get a rate hike this year (there are two more meetings before year end-October 27-28 and December 15-16). In fact, the Fed Chair, in a speech on September 24 at the University of Massachusetts, said:

“Signs of weak growth overseas won't prove large enough to have a significant impact on policy” and added that “most FOMC participants, including myself, currently anticipate...an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter”.

Implications

Unfortunately, postponement of a rate rise has increased uncertainty in markets and may extend the period of volatility we have been living with since late last month. While I'm a firm believer in the current correction “righting itself”, the road may be a bit bumpy along the way. Nothing new there.

For investors betting on a recovery in commodity prices this is not your time nor should bets be made on beneficiaries of higher interest rates (i.e. banks). Beneficiaries of an improving US domestic economy (railroads, chemicals, and consumer discretionary sectors including housing) however may well continue to be the best place to be. At any rate our geographic focus will continue to favour US equities.

Year to date the S&P 500 is down 6.2 per cent in local currency (USD). European equities are down 1 per cent and Japan has gained 2.5 per cent. The Chinese market (CSI 300) is off 8.5 per cent and the Hong Kong traded China H shares are down 10 per cent.

As an Australian investor in AUD however things are still looking pretty good particularly compared to the performance of the ASX which is off some 6.8 per cent. In Aussie dollar terms, the S&P 500 is up 9 per cent (NASDAQ 15 per cent), European equities 6.5 per cent and Japan a whopping 18 per cent. Hong Kong is up 4.4 per cent in AUD.

Fearless prediction

I expect global markets to be higher by the end of the year driven by improving US and European economic data and some stability in Chinese markets.

Actionable ideas

Looking at the 36 names in the Eureka International recommendation list there are a number of individual stocks that given the recent market volatility should be bought now.

For more conservative investors I would be picking up:

Dow Chemical and CSX  - These laggards have good exposure to an improving US economy. Lower energy prices and input costs are also helping margins.

Pfizer - A large cap defensive stock but with a decent growth profile is trading at a discount to the S&P 500 and is a good buy here in the low US$30s.

Walt Disney - Is a strong buy here in low US$100s; I expect film pipeline will produce some upside earnings surprises in the next 6-12 months; theme parks should do well in a stronger US economy.

For investors that can take on a bit more risk:

FireEye - Off more than 25 per cent since July when it was announced the CFO was leaving (and has since been replaced), FireEye is a solid buy here under $US40.00.

Mobileye - Goldman Sachs has just flagged Mobileye as one of the main beneficiaries of self- driving cars stating that: ”Mobileye is a pure play on vision-based autonomous driving software and the leader in driverless cars overall”. MBLY is currently 32 per cent off its recent highs, so I would be an aggressive buyer here in the high $US40s to low $US50s.

Illumina - Buy under $US190.00; a great opportunity to pick up a high flyer. Recent announcements from Democratic presidential candidates Hillary Clinton and Bernie Sanders regarding healthcare reform have pressured life science and biotech stocks.

Splunk  - Just announced that it is partnering with cybersecurity leader Fortinet in order to beef up Splunk's security capabilities; Splunk mentioned on its Q2 call it saw triple-digit year on year bookings growth in the Splunk App for Enterprise Security, which runs on top of Splunk Enterprise. I would be buying Splunk here in the high $US50s to low $US60s. Data analytics remains a high growth area.

Ambarella - Has been under pressure from negative GoPro newsflow but as we have pointed out AMBA is also a play on the proliferation of IP security cams, dash cams, UAVs, and cop cams. I would be a strong buyer here at current prices.

Again I encourage potential investors to read the original stock recommendation piece on the Eureka website: a list of international stock picks, with links to coverage of each stock, is available here.