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Weekly Wrap: Did the Fed Get It Right?

Fri, 16 Jun 2017

We see value in Citi and Wells Fargo even if the Fed should have left rates pat. Plus, a new era for GE.


Video Transcript

Jeremy Glaser: The end of era at GE, and our take on the Fed's rate hike. This time on the Morningstar Weekly Wrap.

Jeff Immelt is stepping down from the top job at General Electric to be replaced by 30-year company veteran John Flannery. Analyst Barb Noverini sees the future for this wide-moat firm as all about execution.

Barb Noverini: Jeff Immelt has certainly experienced his share of challenges and criticism, having led the company through two recessions, cutting the dividend in 2009, and radically repositioning the portfolio from a sprawling conglomerate to the more streamlined industrial portfolio we see today. 

We think that history will ultimately look favorably upon his tenure, particularly since recent efforts have shown good investment in its wide-moat businesses as well as in digital efforts. However, investors have been understandably impatient with the stock's relative under-performance lately. 

New CEO John Flannery is a 30-year GE executive who has recently been tasked with turning around the underperforming healthcare division. His immediate challenge will be to improve investors' confidence in GE, starting with delivering on near-term targets for improving cash flow, while also keeping his eye on the longer-term changes necessary to position GE for success. Ultimately, we think GE's portfolio looks better than ever, and now it's all about execution. 

Glaser: As widely expected, the Fed raised rates this week. But was the economy really ready, or did the Fed feel like they had to act? Bob Johnson thinks the central bank has no choice but to move it this meeting.

Bob Johnson: They were in a situation where they had many governors out talking about it, they had prepped the market for it. Now, if for some reason they didn't have one, they'd say, "Uh-oh, what does the Fed see," and everybody would be running for the hills. So the way they had set this up, they couldn't hardly do anything but raise the rates today, and they did raise them a quarter of a point.

Glaser: And he expects that the Fed won't have room to act again in 2017 on rates.

Johnson: My personal belief is we will not have another rate increase this year. I think that the economy is slowing on many sectors. I think the ability of them to raise rates will be relatively limited. I don't know if it will be entirely clear by their next September meeting, how much things have slowed, but I think it's more likely they'll begin on their balance sheet process rather than do an interest rate hike. If they do an interest rate hike, which I don't think they will, but it'd be more likely to me that it happens in December.

Glaser: For investors, a key question is how higher rates will impact the banking sector. Analyst Jim Sinegal says no matter what they Fed does in the near term, we still like Citi and Wells Fargo.

Jim Sinegal: From our perspective, the effects of the Fed's latest rate hike are not clear cut. It really depends on whether or not they're making the right decision. In the Fed's favor, there has been some positive economic data out lately, unemployment is low, businesses are investing and hiring to some extent. However, one might also ask, what's the rush? Inflation data was very low. We haven't seen much in the way of inflation risk at all coming out. So, it's possible the Fed could be raising rates too early. It looks like that's what the bond market is thinking. Long-term rates are actually down from the beginning of the year. 

If it turns out that this rate hike is too early, it actually could be worse for the economy, worse for banks over the long run. However, if things are actually improving, obviously higher rates are good for banks. That said, we think the banks less exposed to rates are actually the better plays right now. Citigroup has a lot of excess capital, the CCAR is coming up next month. They should be able to raise their dividend, raise their stock repurchases. Wells Fargo had some issues back in October with their sales practices. Again, that's an issue that they can remedy. Not one related to rates, so either way, whether the Fed is right or wrong, we like both of those banks. 

Glaser: In case you missed it on Morningstar.com this week, Karen Wallace took a look at 10 high-quality foreign stock bargains. 

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