Historically, the only thing that heats up during the summer months is, well… the temperature. More recently, though, we’ve seen summer volatility and volumes hovering closer to levels usually seen during the rest of the year.
In these sticky months before the weather breaks, I’ve been thinking about the implications of an enduring, hawkish interest rate policy—a Frozen Fed Summer, if you will, and how those implications might affect how we choose to invest.
Let’s take the (polar) plunge.
At the time of this writing, the target range for the Federal Funds Rate is 4.25%–4.5% and, following the June Consumer Price Index (CPI) report, I believe it’s likely to remain there for the immediate future.
Why? The full impact of tariffs has yet to flow into the indicators the Fed uses to make their decisions. Given the already sticky nature of the CPI and employment data this year, the lack of red flags out of bank earnings thus far, and robust results out of recent promotional days in retail, the odds of near-term cuts are, in my opinion, slim.
So, what does that mean for active investors? Do we fight, flee, fawn, or freeze?
While we at Motley Fool Asset Management avoid making snap decisions based on a single report or headline, we still take trends and the macro environment into account when building our models and adjusting allocations.
You may be thinking, "Well, that doesn’t seem very active of you," but you’d be surprised. I like to say that our ETF products allow investors to get active without breaking a sweat (even in the summer heat).
Coincidentally, one of the best active decisions we can make for our clients is to keep calm. How can we do that in this environment? What’s our North Star?
It’s simple: Quality.
Our active management focuses on our Four Pillars of Quality: Management, Culture, and Incentives (MC&I); Economics; Competitive Advantage; and Trajectory.
The first and third pillars are somewhat immune to the macro environment. The second and fourth, however, are more likely to be affected, at least in superficial ways.
We intentionally seek out companies we believe are run by world-class operators, individuals prepared to control what they can, no matter the economic or trade environments they find themselves in.
The quality of the operators and the value proposition of the product/service should, among other things, generate a competitive advantage amongst peers.
We believe high marks in these areas should be unlikely to be affected by changes in rates, trade policy, or inflation alone. First, these events fail to diminish a leader’s own acumen and general capacity to act wisely given the circumstances. Additionally, these events are happening to everyone, so even when we’re looking at an absolute level change for a peer group, relative performance opportunities are still on the table.
Instead of scrambling to find companies that will never have a bad day, our focus on quality means we’re looking for the ones that should, on average, have much better days than their peers.
There’s no convincing anyone, including me, that the business cycle doesn’t affect the economics of even the highest-quality businesses. Similarly, a company’s trajectory, whether "life gets easier for them" as my colleague likes to say, can also be affected by exogenous events.
The key, however, is relativity: How are these things changing compared to base conditions and, more importantly, to peers?
We look for and invest in companies with robust operating leverage and cash flow in the best and the worst of times, because those metrics should give our investment breathing room—and it gives us, as investors, the active choice to remain calm.
A Frozen Fed Summer gives us neither the shivers nor the sweats.
Because our laser focus on quality (and therefore the investment theses on which our best ideas hinge) doesn’t depend on a summer rate cut, we get to focus on the big picture.
The big picture—not short-term movements of either the market or the Fed—is where we believe the big gains can best come from.
I implore you, dear reader, to join me in the cool waters of the quality pool, where we actively choose level-headedness, patience, and discipline as we navigate the heat.