“Don’t Fight the Fed” was Chapter 4 of the legendary book by investment wizard Martin Zweig Win on Wall Street. He devoted 40 thoughtful pages to explaining to readers why they should âgo with the flowâ when it comes to the Fed’s trend at any given time.
As we recently heard from Fed Chairman Jay Powell himself, the Fed is obsessed with tapering. This will send a select group of dividend-paying stocks to the moon.
I’m talking about “Fed-induced” price hikes of 136% and dividend hikes of 161% as well. (These numbers aren’t taken from the sky; they’re exactly what was delivered by one of the three overlooked regional bank stocks we’ll talk about below. And they’re just the start.)
Read Powell’s Dividend Roadmap
Like toddlers, investors were spoiled as Powell’s quantitative easing program injected $ 80 billion in fresh-minted greenbacks per month into government bonds, plus $ 40 billion. dollars in mortgage-backed securities.
These purchases lowered interest rates and skyrocketed the money supply, with much of this new cash going directly into stocks. It is no coincidence that the S&P 500 followed the increase in the money supply throughout the crisis!
At last Wednesday’s Federal Reserve meeting, Powell ultimately began to shed the habit, claiming that the Fed will cut government bond purchases by $ 15 billion per month, starting in late November.
This will probably cause a temper tantrum among our spoiled investors! But it’s a show: what Powell is really tell us it’s simple: buy bank stocksâespecially small banks, as they will be the biggest winners. And who are we to discuss the advice of Powell and Zweig?
Powell’s Favorite Dividend Producers? Regional banks
Our profit game is based on the yield on the 10-year Treasury bill, which is fixed by supply and demand. The supply (bond issue) is huge, but so too is the demand, thanks to the Fed’s $ 80 billion monthly purchases. As this big buyer cuts back, we’ll likely see the yield on the 10-year note rise (as yields rise as bond prices fall).
All of this pushes Treasury yields up to a rebound above 2% as the Fed exits the market. It might not seem like much, but it’s a 25% increase from here. This creates a huge profit windfall for banks, as Treasury yields set the rates banks charge on consumer loans.
Powell is actually giving us a two-for-one deal here. It artificially depressed bank rates and profits, allowing us to buy their stocks at a low price relative to their future profits. It also (still) prints a lot of money, which increases the demand for loans.
Plus, Jay is such a great guy that he keeps the Fed’s overnight lending rate (which banks lend to each other) at zero, at least for the next few months. This means that the gap between bank borrowing costs and loan profits is increasing.
Our “dividend hat trick” for small banks
All of this makes our banking game pretty clear. And we go after regional banks because their nimble actions are hyper-tuned to Treasury yields.
This is the first part of our small cone-focused banking game. As for parts 2 and 3, we want small banks that are increase dividends or buy back stocks, and ideally both. This is because dividend growth and buybacks are igniting stock prices. (And now is a great time to look for buybacks, with buybacks likely to break the all-time high of $ 224 billion in the third quarter, according to the S&P Dow Jones Indices.)
Buybacks reduce the number of shares in a company because management buys back its shares and cancels them. This increases earnings per share, pushing up stock prices as investors take notice.
You can see the effect of buybacks on stock prices with Financial regions (RF), a holding company of the regional banking ETF that we have just mentioned. RF has branches in the South and Midwest and is reporting 2.8% today. Bank buybacks over the past five years have provided a floor for the stock, sending it higher as management slashed outstanding shares by 21%.
Now let’s talk about dividends, because few people realize that they too are igniting stock prices. And payments are expected to rise as Powell eases his purchases from the Treasury.
The link between dividends and stock prices, a phenomenon I call the âdividend magnet,â is easy to spot. You can see the price go up with every dividend increase (the spread between the regions share price and the dividend is our advantage).
Supported by its buybacks and the increase in dividends, Regions’ stock recovered from the 2020 crash. The continued reduction of Powell will fuel both dividends and buybacks, pushing the actions of the Regions even higher!
By the way, this is far from a âone-bankâ phenomenon. Let’s get a few more holdings out of our ETF – you’ll quickly see the exact same setup in action, making these banks good ‘taper take off’ sets too!
As with Pennsylvania PNC Financial Services
PNC PR P
Finally, there is the Pasadena base Bancorp East West
EWBC has increased its payouts by 65% ââover the past five years, resulting in an almost parallel share price gain (with a lower percentage of shareholder returns in buybacks).
The bottom line? The predictable pattern of rising dividends, shrinking stocks and rising share prices makes any of these three banks a solid choice for the next downturn – and fits perfectly with the timeless advice of Zweig to follow – do not fight – the Fed.ght – the Fed.
Brett Owens is Chief Investment Strategist for Contrary perspectives. For more great income ideas, get your free copy of his latest special report: Your early retirement portfolio: 7% dividends every month forever.