The Man Selling the Fed’s Secrets

I’d be surprised if you’ve heard of Larry Meyer, but in the past few days, he’s created quite a buzz.

Larry Meyer is a former Federal Reserve Governor. He holds a B.A. from Yale; a Ph.D. from MIT. His pedigree is top-notch. So are his connections.

Meyer is still buddies with the folks on the Federal Open Market Committee, the policy-making body of the U.S. Federal Reserve. And his friends tell him what goes on at their meetings weeks before the general public gets to read about it.

You would think sharing that information with anyone outside the current Fed members would be illegal. You would also think the fact that Meyer charges well-heeled clients $75,000 each for access to what he has heard — well ahead of the investing public — would be unlawful. Amazingly, neither action is illegal, according to a Reuters investigation.

One of the Federal Reserve’s main tools is setting target interest rates, and profits can be made or lost based on what the Fed says at its meetings. It makes me mad (and likely you too) that some have inside access. But there is a way to fight back.

I think we’ll be much better off finding a few good income investments that are simply less sensitive to interest rates.

Why interest rates matter to income investors
When interest rates rise, the price of some fixed-income securities, like bonds, tend to fall. For an extreme example, you wouldn’t want to hold a risky corporate bond paying a 7% yield if you could now get a safer 10-year Treasury bond paying 7%.

So when the interest rates of Treasuries rise, investors tend to shed their riskier assets. This causes the price to drop — and the yields to rise — ultimately making riskier fixed-income securities more competitive when compared with safer investments.

It’s the number one reason why income investors are obsessed with what the U.S. Federal Reserve is likely to do with interest rates. And why some pay $75,000 for Larry Meyer’s analysis.

The two primary reasons the Federal Reserve raises target rates is to slow the economy and/or to prevent out-of-control inflation. But last I looked, the economy wasn’t overheating. In fact, the U.S. economic recovery is plodding along.

The U.S. economy grew by only +1.7% in the second quarter of this year. Economists are forecasting a possible +2.1% growth rate for the remainder of the year. Unemployment continues to remain high. And until people are back to work, personal consumption — a primary engine of the U.S. economy — will be constrained.

Meanwhile, inflation is running below 1.2% — well below the level where the Federal Reserve starts breaking a sweat.

But this will eventually change. Interest rates are at historically low levels and in all practicality can’t go much lower. When the economy finds more solid footing, you can rest assured that the Fed will be moving rates north.

You don’t have to pay someone $75,000 to figure this out.

Two interest rate-friendly strategies with above-average yields
Knowing that rates will eventually rise, I am picking up income investments for my Daily Paycheck portfolio that provide more protection in a rising rate environment. And I’m not sacrificing yield to do it.

Action to Take –> Here are a couple of spots I’m looking:

Bonds with the Potential for Credit Upgrades: In my bond selection, I’ve tried to pick issues that have a good chance of achieving a rating upgrade. When the credit rating (and thus the perceived safety) of a bond improves, its price rises — while its yield drops in line with other similarly safe bonds. This will give these investments more of a price buffer when interest rates rise.

For instance, I bought shares of Ford Motor Credit 7.60% Notes (NYSE: FCJ) in April for my real-money portfolio. In the worst of the financial crisis, the credit rating on this issue was an ugly “Caa1.” When I purchased the notes, they had already been upgraded to “B1” — still highly speculative. They have subsequently been upgraded to “Ba3.” Based on Ford’s current numbers, I think future upgrades are likely.

Floating Interest Rate Securities: When it starts looking as if a rise in interest rates is imminent, I plan to rotate out of some of my more interest rate-sensitive investments and into investments with more appreciation potential, like floating-rate preferred stocks and bonds. These securities automatically pay higher distribution rates when interest rates rise. While it’s hard to purchase individual floating-rate securities, there are a number of closed-end funds that specialize in these stocks and bonds.

In my October issue of The Daily Paycheck, I even picked a floating-rate bond fund as my “Security of the Month.” The fund currently has a yield of 7.6% and pays monthly distributions. I’m adding 335 shares to my $200,000 portfolio. (Sorry, in fairness to Daily Paycheck subscribers, I can’t give its name. But if you’d like to join me, you can read all the details in this month’s issue. Click here for more information.)

So you can go ahead and pay $75,000 to Larry Meyers. Or you could invest your money in two income strategies that are less sensitive to rising interest rates. I know which I’ll be doing.