Must-know: How the Fed influences restaurant sales

Part 7

Does the “don’t fight the Fed” strategy actually work?

The “don’t fight the Fed” strategy

Because what the Fed (the central bank) does can have a significant impact on the economy and stock market, its policies are widely followed by money managers, analysts, traders, and investors. When the Fed loosens monetary policy, it’s often see as a positive. Conversely, when it tightens monetary policy, it’s something to be aware of. That’s where the “don’t fight the Fed” approach comes from.

US Interest Rate, Inflation and S&P 500 2013-09-23Enlarge Graph

Does “don’t fight the Fed” work?

Some could interpret the idea of “don’t fight the Fed” as not selling when the Fed loosens monetary policy and starting to take profits when the fed tightens. That kind of interpretation can get you into trouble because the world isn’t that simple. The Fed has a lot of power, but it isn’t the only force that acts on the market. For the past ten years or so, the idea of “don’t fight the fed” would have made and lost money. The question was when and in what kind of situation. If investors had gotten into the market when the Fed was lowering rates throughout 2000 to 2003 and 2008, they probably would have lost a lot of money. But if they had used this strategy from 1983 to 2000, they would have made money overall. When the Fed increased rates, the stock market fell. When the Fed lowered rates, the market rose.

A theory 

It might just be that when interest rates reduce as a reaction to a crisis, the collective mass is likely to overpower the Fed in the short to medium term. During times like the early 2000s and 2008, the Fed had no option but to ease because something in the world was collapsing. After it brought interest rates to a low, though, the market eventually knelt to the Fed because it realized the central bank would do anything to prevent a meltdown and total collapse of the financial system. The world depends on the Fed’s intervention. So are falling rates or low rates great for stocks? Generally yes, but this would depend on the catalyst driving the stock market at the time. If the Fed were loosening monetary policy to fight chaos, fear, or problems in the market, then it’s probably best for investors to pick a different time.

Are rising rates positive?

Contrary to what most investors may believe, rising rates over the past ~40 years have been positive for the stock market. The only time this has negatively impacted the S&P 500 was when oil price shot up in 1973. The central bank had to raise the interest rate due to risk of hyperinflation. But caution is needed, however, because higher inflation rates have historically preceded market falls. The degree of the fall depends on the situation as well.

Why this is important to restaurant companies

Restaurant stocks, like any other stocks traded in the market, are subject to systematic risk. These are risks that can’t be diversified away by investing in other companies or industries because the catalyst for this kind of downfall is driven by macro events that affect every business. That’s why when the S&P 500 fell from ~1550 to ~780 in a matter of months, every single restaurant company—McDonald’s Corp. (MCD), Yum! Brands Inc. (YUM), AFC Enterprises Inc. (AFCE), and Chipotle Mexican Grill Inc. (CMG)—to name a few, were negatively affected. Nonetheless, with interest rates at a record low, inflation tame, and the Fed doing its best to bring unemployment down, these companies are more likely to rise than fall over the long term. This also applies to the Dow Jones Consumer Services ETF (IYC).

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