Which 2 US Counters do Savvy Investors Favour? July 6, 2023
At the most recent Federal Open Market Committee (FOMC) meeting in June, the Federal Reserve (Fed) maintained interest rates within the current range of 5% to 5.25%. However, it is expected to raise interest rates again, at least twice this year. This announcement seems to suggest that interest rates are peaking, giving some hope to the stock market.
Instead of celebrating, it’s important to consider how long the high interest rates will persist as an extended period of high interest rates can carry negative implications for the market and the overall economy. Prolonged high interest rates can lead to a reduction in economic activity and potentially result in a recession.
In such an environment, which two US counters do savvy investors favour?
The first US counter is:
#1 iShares 20+ Year Treasury Bond ETF (TLT)
Reason 1: Safe Haven
US Treasury Bonds are regarded as the safest form of investment due to their backing by the US government. Moreover, the US hasn’t defaulted on its debt since 1971.
Reason 2: Inverse Relationship Between Interest Rates and Price
The price of bonds, especially long-term bonds, is sensitive to changes in interest rates. When interest rates fall, the price of long-term bonds typically rises more substantially compared to short-term bonds.
Savvy investors, predicting that interest rates are about to peak, view long-term Treasury bonds as an attractive choice for potential capital appreciation when the Fed eventually reduces interest rates. As TLT tracks the performance of the US Treasury 20+ Year Bond Index and maintains a diversified portfolio of US Treasury bonds with maturities of 20 years or more, it is favoured by savvy investors in the current economic climate.
However all forms of investment come with their associated risks:
Risk 1: More Interest Hikes Than Anticipated
The Fed has previously implemented interest rate hikes with the aim of controlling inflation. They have increased interest rates seven times in 2022 and a further three times in 2023. If the Fed raises interest rates more than anticipated, this could negatively impact TLT’s price.
Risk 2: Yield May Be Lower Than Bonds
TLT is an exchange-traded fund (ETF). ETFs typically offer lower yields as they track a broader market.
If you’re convinced that interest rates are set to peak in the near term, followed by a long-term decrease, then TLT could be a suitable investment for you. It’s especially suited to those who can hold it for an extended period. If you’re more comfortable investing in a long-term Treasury Bond ETF, then TLT is certainly an option worth considering.
So, which is the second US counter that savvy investors favour?
The second US counter is:
#2 Pepsico (PEP)
Reason 1: Defensive Stocks
PEP belongs in the Consumer Staples sector, which is defensive in nature.
As the threat of a recession still looms, you will want to be equipped with defensive stocks to weather the storm. This defensive stock ought to be cash rich to tide or even rise above the storm.
Reason 2: Cash Rich
In an expanding economy, banks and other financial institutions are more willing to grant loans with lenient terms. Conversely in a contracting economy, loans are only granted with stricter terms or higher interest rates to absorb the risk involved.
As interest rates are set to rise in the near future, the cost of borrowing will increase, potentially causing loan-reliant companies to falter. However, the strongest and most financially astute companies will survive.
Companies with substantial cash reserves are more likely to thrive in environments with high interest rates or pessimistic market conditions. In this respect, PEP has a healthy 10% net margin and a war chest of US$4.7 billion. These are positive indicators that PEP is likely to weather challenging market conditions effectively.
Reason 3: Uptrend
While many stocks are still struggling to recover from their 2022 losses, PEP has consistently been setting new all-time highs, as can be seen from the weekly price chart shown below.
Even the S&P 500 (SPY) hasn’t fully recovered from its 2022 losses, as shown below.
However, there are associated risks with all investments.
Risk 1: Product Recall
Any recall of PEP’s products by the Food and Drug Administration (FDA) could significantly impact its share price.
Risk 2: Interest Rates Pause
If there’s a pause in interest rate hikes, savvy investors may divert their capital from defensive stocks to riskier assets.
PEP is a suitable investment if you are a short to midterm investor (1 to 5 months). By applying the STARS framework, I’ve identified potential turning points for PEP by plotting support and resistance levels and trendlines.
STARS is an acronym for
- Support and resistance
- ATR indicator
- RSI indicator
As usual, we favour the pullback strategy.
We believe that the share price of PEP has further potential to increase in the coming weeks before experiencing a pullback. This could present you with an entry opportunity at around US$185, with a stop loss at approximately US$171.50 (derived from using a 2.5x ATR value below your entry price), and a take profit at around US$200 (which is the immediate resistance zone).
In conclusion, understanding the larger macroeconomic landscape allows you to navigate the financial markets with greater clarity and confidence. Despite the ever-changing market conditions and economic climate, opportunities for investments are constantly present. They simply require careful observation and strategic decision-making.
This proactive approach, which involves identifying potential investment opportunities and responding to economic cues, is what sets a savvy investor apart from the rest.
However, it’s crucial to remember that while we’ve highlighted the potential of TLT and PEP based on current market conditions, it’s essential to undertake your own due diligence and consider your financial situation and investment goals before making any investment decisions. Stay informed, stay agile, and above all, stay invested in your financial future.
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About the author
Benjamin Tay (Dealing) and Jack Lee (Dealing)
Benjamin graduated from the State University of New York at Buffalo with a Bachelor’s degree in Business Administration. He believes that a strong foundation is absolutely necessary to succeed in the financial markets.
Therefore, he enjoys sharing his knowledge and experience to help others succeed. In his free time, he enjoys reading books on business, fish keeping and spending time with his family.
Jack Lee graduated from the University of Nottingham with a Bachelor’s degree in Business Economics and Finance. Companies with unique business models excite him. He is highly passionate about sharing his findings to help clients benefit from long-term high growth stocks. Thus, he is always on the hunt for stocks with value and potential for high growth.