Noise vs. News: Fed Meetings and Rates

By Joe Ponzio on November 2, 2007  |  10 comments

Sorry all — the Chicago cold kicked my butt for two days. Let's get back to business. The Federal Reserve cut the federal funds rate by 25 basis points (0.25%) and pumped $41 billion of short-term reserves into the markets — the biggest liquidity infusion since September 11, 2001. One would have expected stocks to do anything but drop — the Dow having lost 360 points (2.6%) yesterday.

So...

Mr. Buffett:

Stop trying to predict the direction of the stock market, the economy, interest rates, or elections.

Great businesses will grow regardless of most rational interest rate changes (we can't do anything if the fed raises them 10% in a day). For example, Buffett bought Coca-Cola in 1988 — when the Federal Funds Rate was rising from 6.5% to 9.75% in that same year. Why?

On a day-to-day basis, most businesses operate regardless of the fed rate — and completely independent of it. Coca-Cola sells Coke by the truck load regardless of the trickle-down effect of the Federal Funds Rate. In addition, it generated gobs of excess cash that allowed it to service virtually any interest rate the banks threw at it.

Of course, Coca-Cola generated so much cash that the banks bent over backwards to throw money at them. (Hint: Look for companies generating tons of cash — companies that can muscle the banks)

But My Stocks Are Down!

Of course your stocks are down. On a day-to-day basis, the markets can do crazy things. Over the long-term, they will increase the prices of valuable companies and lower the prices of bad businesses.

In the short run, the market is a voting machine. In the long run, it's a weighing machine.

The Business Owner

Back when Gillette was a publicly traded company (it is now a subsidiary of Procter and Gamble), Buffett said:

You go to bed feeling very comfortable just thinking about two and a half billion males with hair growing while you sleep. No one at Gillette has trouble sleeping.

Does a business owner/manager care about the fed rate? For the most part, no. Unless that business is so highly leveraged that its cash flow can barely handle the current debt service, it will be business as usual at the company — with perhaps a smidgen more or less free cash flow at the end of the year.

This Morning At Your Company

What happened this morning at your companies? If you own Blackstone Group (BX), you may not know. Their highly leverages, rate-sensitive investment strategy may be allowing them to profit handsomely from this rate change. Or, they may have gotten crushed overnight as the fed rate moved against them.

I don't really know. What I do know is that everyone at Coca-Cola likely went to work today to process the day's orders, handle the invoices, ship cases of Coke, and work to make Coca-Cola more profitable. The fed rate is probably very low on the water cooler "things-to-talk-about" list.

Fed Rates: Noise Or News

If you own great businesses with lots of excess cash flow — businesses that are not sensitive to every blow of the wind — fed rate changes are mostly noise. If, on the other hand, you are gambling in companies with thin cash flows and sensitive business models, the fed rate is news — and the house will usually win.

Ask A Small Business Owner

It is difficult to compare a highly sensitive, highly complex business to that of a small company — but the comparisons are scary when you look at simple, slow-changing businesses vs. small businesses. Simple, slow-changing businesses are easier to value — and as such, it makes sense to compare them to small companies.

Ask a small business owner how the fed rate affected him or her today. More times than not, they'll look at you funny — as if they didn't even know the rates have changed and as if the rate change won't affect the phone calls, sales, and billing they'll do today.

Those are the businesses you want to own.

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