Stock Market: The Powell Pivot is Good News For Both Bonds and Stocks

Gordon Pape | January 13th, 2024

With the feds prepared to cut rates this year to ensure the U.S. doesn’t tip into recession, companies that had seen their market price sink during the tightening period have enjoyed a strong rebound. Photo: Thom Lang/Getty Images

Rate cuts. It’s amazing what those two little words can achieve.

Stock markets moved higher in December after the U.S. Federal Reserve Board sent signals that almost two years of steady rate increases are over. Not only that, but the target is to implement three rate decreases in 2024.

No one said those precise words. In its Dec. 13 policy announcement, the Fed said it would hold the line at the current level of 5.25 to 5.5 per cent. The statement issued by the Open Market Committee contained the usual message that members would monitor developments and “adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals.”

So, what made people so excited? A dot plot chart, that’s what. It’s called the “Summary of Economic Projections,” and it depicts what the Fed thinks will happen with GDP, inflation, unemployment, interest rates and other indicators in the coming years. A close look shows three projected quarter-point cuts in 2024, with more to come in 2025 and 2026.

The media are calling it the “Powell Pivot,” after Fed Chair Jay Powell. Call it whatever you want, but the reality is we’ve seen a fundamental change in direction.

In its official statement, the Fed said: “Recent indicators suggest that growth of economic activity has slowed from its strong pace in the third quarter. Job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low. Inflation has eased over the past year but remains elevated…”

That may sound somewhat pessimistic, but it’s quite the opposite. An economic slowdown to curb inflation is just what the Fed wants – the so-called soft landing. To achieve that, it’s prepared to cut rates this year to ensure the U.S. doesn’t tip into recession. The only uncertainty at this point is when the easing will begin.

The bond rally, which began in November, continued through December. Stocks surged on the news, with the Dow hitting an all-time high in the hours after the statement came out. Some companies that had seen their market price sink during the tightening period enjoyed a strong rebound. One was Brookfield Infrastructure Partners (BIP.UN-T).

The Fed’s move is an auspicious sign for 2024. But it would be prudent to remember it’s based on the assumption the inflation rate will continue to drop towards the two-per-cent target. If that doesn’t happen, the Fed will be forced to resume tightening. Both stock and bond markets would be hit hard in that event. So enjoy the rally, but don’t get too exuberant. There are two other little words that could pull the rug out from under this incipient bull: “rate hikes.”

Here’s a more detailed look at the Brookfield partnership I mentioned earlier.

Brookfield Infrastructure Partners (BIP.UN-T)

Type: Limited partnership (LP)

Current price: $40.47

Annual payout: US$1.53

Yield: Five per cent

Risk: Moderate

Website: www.brookfieldinfrastructure.com

Comments: The unit price tumbled to a five-year low of $29.12 in October before staging a rally. Rising interest rates hurt companies with high debt loads – the LP had almost $39 billion (figures in US dollars) in non-recourse borrowings at the end of September, up 46 per cent from the same time in 2022. Worries about a recession that could hit revenue also discouraged investors.

The only benefit from the decline in the unit price was a big jump in the yield. At the October low point, investors were collecting 7.3 per cent, based on a quarterly distribution of US$0.3825. The price recovery since then has knocked the yield back to five per cent, but that’s still attractive, and an increase in the distribution is expected this year.

Third-quarter results showed funds from operations (FFO) of $560 million ($0.73 a unit), a seven per cent increase compared with the same period last year. Management said revenue benefited from strong base business performance and the commissioning of approximately $1 billion of capital projects in the past 12 months.

“Our financial results do not reflect the benefit of new investments this year, and we are conversely impacted by nearly $2 billion of asset sales that primarily closed in the second quarter of 2023,” management said. “The fourth quarter will fully reflect the contributions of our new investments, which closed right before, or subsequent to, Sept. 30.”

For the first nine months of the fiscal year, the LP reported FFO of $1.7 billion ($2.16 per unit) compared with $1.5 billion ($1.99 per unit) last year.

Management said current conditions “have created a strong environment for capital deployment, with returns on new investments expected to be well in excess of our 12-15 per cent target. Our 2023 deployment is expected to provide us with some of the best risk-adjusted returns we have seen in the last decade.”

One of its largest deals is the acquisition of Triton, which closed on Sept. 28. The $13.3 billion deal was announced in April. Triton is the world’s largest lessor of intermodal freight containers. The LP is also acquiring all of Cyxtera for $775 million. Cyxtera operates a global network of data centres.

At this point, I see BIP as a buy. The yield is attractive, and the LP is aggressively adding profitable new businesses to its portfolio.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.

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