If Fed raises interest rate, look at long term and don’t panic, investing experts say

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In Omaha, the spiritual home of the investing style that ignores short-term market gyrations, the prospect of a change in Federal Reserve interest rates is kind of a yawner.

“To our way of thinking, those who want to act on the possibility of a rate change — or not — are speculators, not investors,” said Tom Sudyka, managing director at Lawson Kroeker Investment Management, which employs value-investing strategies.

The Fed’s rate-setting committee meets Wednesday and Thursday to ponder modifying the overnight rate at which banks lend to one another. But it’s not just banks that care about the fed funds rate. It serves as a benchmark for interest rates that influence everything from car loans to home mortgages to business credit lines.

That rate has been set near zero since December 2008, as the Fed embraced a low-rate policy some economists said was useful because it flooded the financial system with cash and encouraged economic growth.

Even if the Fed does push the button on a rate rise when it finishes its two-day meeting, most economists and market watchers who expect an increase envision only a small one — probably a quarter of a percentage point.

Sudyka said an interest-rate change probably will add volatility to the market, or the swinging stock prices that work to the advantage of investors who attempt to time the market or profit from short-term fluctuations.

But from a value standpoint, that isn’t intelligent investing, said Sudyka, whose firm manages about $500 million.

When it comes to the Fed this week, investors such as Sudyka who pay most attention to the long term — regardless of immediate gains or losses — will be watching out of only one eye.

That’s because they follow the principles outlined decades ago by professional investor and Columbia University business professor Benjamin Graham. He said that “investing is most intelligent when it is most businesslike,” meaning that it is devoid of the emotion and off-the-cuff reaction that might be motivated by short-term fiscal, monetary or political developments.

“As a value investor, I’m in for the long haul, so month-to-month and quarter-to-quarter rate changes aren’t going to keep me out of the market,” said Jerry Pettit, a retired Omaha tax attorney who went into professional money management after he was profiled in Forbes magazine last year for achieving good returns managing his own portfolio.

“I wouldn’t do anything different even if I knew there was a rate increase coming,” Pettit said. He recently incorporated his Pettit Funds, which is starting out managing about $4 million.

The value investing style became interwoven with Omaha after proponent Graham had a pupil in the 1950s who turned out to be a star: Omaha’s Warren Buffett, chairman and chief executive of Berkshire Hathaway and the most famous advocate of ignoring tumult and evaluating stock-market investments as businesses worth owning in their entirety or not, as opposed to mere blips on a stock-ticker buffeted every which way by war, famine, natural disaster and interest rates.

Because of Buffett, Omaha has become something of a hotbed for value investing. Omaha also is home to a large handful of professional money managers who embrace the style in some of their portfolios.

And some of those investors aren’t too hyped about interest rates that could rise.

“I do not know what the Federal Reserve will do concerning interest rates,” said value investor Russ Kaplan, whose Omaha-based firm of the same name manages about $15 million. “It will not change my equity investments one bit.”

Kaplan, whose top current stock picks include construction equipment maker Caterpillar, said he never has said yes or no to a stock investment based on interest rates or any other factor he considers only marginally related to the company itself. That is one of the cornerstones of value investing, he said: evaluating stocks based not on their movements, but if they represent a stake in a prosperous company that would be worth owning in its entirety.

That being said, Kaplan expects rates to begin rising at some point.

If that happens, tax-exempt bonds would be more attractive than taxable ones for investors in a high-income tax bracket, he said. That’s because tax-exempt government bonds, like all other bonds, would pay investors higher interest rates if the Fed rate rises. And investing in tax-free bonds as opposed to taxable ones lowers tax liability.

Tom Carney, manager of fixed-income portfolios at Omaha’s Weitz Investment Management, said there is a complex interplay between interest rates and the implications for bond investors and bond sellers. Weitz has about $6 billion under management.

“Rising rates can benefit new investors at the expense of new issuers — and vice versa,” Carney said. “But it’s difficult to generalize, since the rate of future economic growth and inflation will play important roles in how the economics between investors and issuers play out over time.”

Weitz Investment founder and Chief Investment Officer Wally Weitz, the second-largest value investor in Omaha after Buffett, probably has never made a decision based on what he thinks the Fed is doing, Carney said.

“But if other investors create mispricing of securities we either own or would like to own at the right price, we will eagerly take advantage of the opportunity,” he added.

Economists nationally have changed their minds on when a rate increase will happen; 46 percent surveyed by the Wall Street Journal last week said they expect a raise this week. Last month, 82 percent said so. Now, a majority expects the Fed will wait until October or later to raise rates.

Rob Furlong, a portfolio manager at Omaha’s Carson Wealth, is one of the finance professionals who doesn’t think the Fed will raise this month.

“The stronger dollar, weak commodity prices, the rest of the world battling deflation and the recent global market turmoil is probably enough to keep the Fed on the sidelines for now,” said Furlong, whose firm employs value strategies. “It is very reminiscent of 1998, where the Fed signaled rate increases all year with an improving domestic economy, but global turmoil actually led them to cut rates by the end of the year.”

As for how other money managers would react to a rise, Furlong said, “I do think others will modify their behavior. It’s been nearly a decade since the Fed last raised rates. It’s hard to believe, but there is a whole generation of investment professionals today that have only ever experienced highly accommodative monetary policy.”

(Though the Fed made its last move on rates in 2008 — pushing them to their current near-zero — the last time the Fed raised rates was in 2006.)

In any case, said Furlong, whose firm has about $6 billion under management, individual investors should sit tight.

“The last thing individual investors should do is make reactionary decisions with any situation,” he said.

George Morgan, a finance instructor at the University of Nebraska at Omaha and a value-investing scholar, said he sees no immediate economy-related reason to raise rates. If wages were rising quickly, the Fed might need to move rates higher more quickly in order to put a brake on inflation, but wages are rising only modestly, at best, Morgan said.

“Most of the current posturing is more political than economic,” Morgan said of Fed officials who have hinted that this week’s meeting will be the one when they push the button to raise rates.

“My best guess is that we will see a rate increase sometime in the next few months,” but the change will be slow, he contends. Most likely, the Fed will inch ahead a quarter of a percentage point at a time every few months, he said.

As with any development where politics and economics cross, Morgan said there will be people trying to make money off of the decision — whatever the decision is — by urging clients to tear up their playbooks and start over.

“When the Fed does finally announce they are going to do something, (CNBC talk show host) Jim Cramer and his ilk will pound their fists and yell and scream — but this, too, will pass,” Morgan said.

Such rash moves are the exact opposite of the long-term, steady-as-she-goes value-investing philosophy.

“What the Wall Street money managers will do is tell everybody that adjustments have to be made, because adjustments generate fees and attract money,” he said.

Omaha World Herald

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