The Fed’s Big Decision: 25 or 50 Basis Points?
As we approach the Federal Reserve’s highly anticipated rate decision, the financial world is abuzz with speculation. Will it be a 25—or 50-basis-point cut? I am here to break down the situation and offer my thoughts on what is likely to happen and why it matters.
The Current Landscape
We are at a crucial juncture. Since St. Patrick’s Day 2022, the Fed has been on a mission to combat inflation, hiking rates by a staggering 500 basis points in just over a year. For the past 14 months, they have held steady. Now, we are on the brink of a regime change. The “higher for longer” era is coming to an end, and we are about to enter a long down cycle.
The Case for 25 vs. 50
The debate over whether to make a 25- or 50-basis-point cut is intensifying. Currently, about 70% of the money is betting on a 50-basis-point cut. But here is my take: a 50-basis-point cut would signal that the Fed has information far worse than anything we see publicly.
The data we have observed so far justifies a 25-basis point cut. We need to get back to the natural interest rate, which under normal conditions would be around 2-2.5%. Factoring in AI growth and ongoing government spending, we are probably looking at a 3-3.5% natural rate. That is still 200 basis points lower than where we are now.
Market Contradictions
Interestingly, while markets are pricing in a 50-basis point cut, there is a contradictory narrative at play. Many are talking about a soft landing and AI taking us to new heights, yet they’re buying utilities and selling oil stocks – a classic recessionary move. This disconnect between rhetoric and action is telling.
Economic Indicators
Recent economic data paints a mixed picture. Retail sales were better than expected, consumer sentiment improved slightly, and we saw a positive Empire State Manufacturing report for the first time since 2022. However, inflation remains sticky, particularly in rents, and geopolitical factors could easily spark inflationary pressures beyond the Fed’s control.
The Fed’s Balancing Act
The Fed is walking a tightrope. They need to manage full employment, control inflation, and now, tacitly, keep federal interest payments in check. All this while avoiding a crisis of confidence or reigniting inflation. It is a delicate balance that requires caution and precision.
Investment Strategy
In this uncertain environment, I advocate for focusing on high-yielding companies with strong fundamentals. Names like NextEra Energy Partners, FSK, Franklin BSP Realty Trust, CBG, Western Union, and Ladder Capital are on my radar. Devon Energy and Corterra Energy stand out for those looking at the energy sector, especially given the potential for natural gas demand to explode higher in the coming years.
In this uncertain environment, I am advocating for a focus on high-yielding companies with strong fundamentals. Here are some names that stand out:
- NextEra Energy Partners (NEP): This renewable energy company is reaffirming higher dividends for this year and projecting dividend growth of 6-8% over the next several years. As a leader in the clean energy transition, NEP offers exposure to the growing renewable sector with the stability of utility-like cash flows.
- FS KKR Capital Corp (FSK): One of the few high-quality business development companies (BDCs), FSK is performing well and offering a substantial 12.89% dividend yield. It provides customized credit solutions to private middle market U.S. companies and has a diversified portfolio across various industries.
- Franklin BSP Realty Trust (FBRT): With a 10.48% dividend yield, FBRT has a fantastic portfolio primarily consisting of loans for multifamily projects. The company boasts high-quality assets with very low delinquency rates and negligible default concerns.
- CGBD (Carlyle Secured Lending): Another well-run BDC, CBG offers an 8.71% yield. It focuses on providing flexible financing solutions to middle-market companies and benefits from The Carlyle Group’s global investment firm’s expertise.
- Western Union (WU): This global leader in cross-border, cross-currency money movement and payments yields 8%. Despite recent stock sell-offs, Western Union’s established brand and global network position it well in the remittance market.
- Ladder Capital (LADR): One of the most conservative commercial mortgage REITs, Ladder Capital has significant capital to deploy in a depressed market. This positions them well to capitalize on opportunities in the commercial real estate sector.
- Comcast (CMCSA): While not a high-yield play, Comcast is incredibly shareholder-friendly. Their broadband business is fantastic, and despite complaints about cable service, they own the infrastructure. This positions Comcast as a potential massive winner in the coming years, and the stock is currently undervalued.
- Devon Energy (DVN): This oil and gas producer has seen recent sell-offs, making it an attractive opportunity. Devon operates with a variable dividend policy, with total dividends expected to reach around 4% this year. They are also aggressively buying back stock, demonstrating confidence in their long-term prospects.
- Corterra Energy (CTRA): If I had to pick just one stock out of the twenty, it would be Corterra. I am impressed with their management, business strategy, and shareholder capital return policy. The stock is down 17% for the year, presenting a potential buying opportunity. With natural gas demand expected to rise significantly due to AI and data center power needs, Corteira is well-positioned to benefit from this trend.
Natural Gas Demand Outlook
When considering investments in the energy sector, particularly in companies like Devon Energy and Corteira Energy, it is crucial to understand the outlook for natural gas demand over the next several years. Based on current trends and emerging factors, I anticipate a significant increase in natural gas demand, which could have substantial implications for the market and these companies.
Factors Driving Demand
Artificial Intelligence and Data Centers: The rapid growth of AI technologies is driving an unprecedented demand for data center capacity. These data centers require enormous amounts of power, and many are turning to natural gas as a reliable and relatively clean energy source. We are already seeing discussions about building small natural gas plants specifically to power AI and data centers.
Industrial Reshoring: The trend of bringing manufacturing and other industrial processes back to the United States is gaining momentum. This “reshoring” movement, particularly in semiconductor and other technology industries, will likely increase domestic energy demand, with natural gas being a key beneficiary.
Transition from Coal: As environmental concerns continue to mount, we are seeing a gradual shift away from coal-fired power plants. Natural gas is often the preferred replacement due to its lower emissions and the ability to ramp production up or down to meet demand fluctuations quickly.
LNG Exports: The United States has become a major exporter of liquefied natural gas (LNG) in recent years. As global demand for cleaner energy sources grows, particularly in Asia and Europe, U.S. LNG exports are expected to continue increasing.
Residential and Commercial Use: While efficiency improvements may temper growth, population increases and economic expansion are likely to sustain demand in the residential and commercial sectors.
Natural gas prices have been relatively low recently, but I see signs that this could change. The cash markets for natural gas are showing interesting movements, potentially signaling a trend change. While we have seen false starts before, we are approaching a point where prices could break out significantly to the upside.
It is worth noting that natural gas prices have been highly volatile. In 2022, prices reached the $9 range. While it would be speculative to predict a return to those levels, increasing demand and potential supply constraints could drive prices higher.
This outlook presents some intriguing opportunities for investors. Companies well-positioned in the natural gas space, particularly those with strong production capabilities and efficient operations, stand to benefit significantly. This is why I am particularly bullish on companies like Corterra Energy, which I believe is exceptionally well-managed and has a shareholder-friendly capital return policy.
However, it is essential to remember that the energy sector can be volatile. While the long-term trend for natural gas demand looks positive, short-term price fluctuations can be significant. Investors should be prepared for this volatility and consider it in the context of their overall portfolio strategy.
Make the volatility work for you and not against you/
Over the next several years, the outlook for natural gas demand appears strong, driven by technological, industrial, and global energy trends. While predicting exact price movements is always challenging, the fundamentals suggest a favorable environment for well-positioned natural gas producers. As always, thorough due diligence and a long-term perspective are crucial when considering investments in this sector.
These companies offer a mix of high yields, strong fundamentals, and exposure to sectors with promising long-term prospects.
My approach remains focused on value, dividends, and buybacks. I look to add companies with excellent long-term prospects coming off periods out of favor in the market. This contrarian approach and collecting substantial cash dividends have served me well for decades. We wait for our companies to be repriced dramatically higher over time, a strategy I expect to continue working in the future.
Conclusion
As we await the Fed’s decision, it is crucial to remember that while this is a significant event, it’s just one piece of a larger economic puzzle. Whether it is 25 or 50 basis points, the key is to stay focused on long-term value, dividends, and companies with excellent prospects that may be temporarily out of favor.
My strategy remains unchanged: collect cash dividends, buy undervalued companies with strong fundamentals, and wait for the market to reprice these assets higher over time. It is an approach that has served me well for three decades, and I expect it to continue delivering results in the years to come.
Stay tuned, stay informed, and most importantly, stay disciplined in your investment approach. The noise will be deafening in the coming days, but remember – it is the long game that truly matters.