Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / How the Fed's Rate Path Shapes Your Stock Picks
Transcript
- Lucas: So the S&P 500 is hovering around 7,676, basically flat on the week, but underneath that calm surface, there's a real rotation happening. Small caps are down two percent, energy is mixed, and the ten-year Treasury is creeping higher. That's a backdrop where stock picking either gets a lot easier or a lot harder, depending on how you read it. Luna: I feel like every time the Fed sneezes, the market catches a cold. But this week feels different. Chevron's up two percent while Exxon's down a percent, and that's within the same sector. Lucas: Exactly. And that's the kind of dispersion a stock picker can exploit. The market is pricing in higher odds of a rate hike at the September FOMC meeting, and that's hitting rate-sensitive names differently. Banks like JPMorgan and Bank of America are basically flat, but they've been resilient because higher rates actually help their net interest margins. Meanwhile, growth names like Microsoft are up four percent, which seems counterintuitive if rates are rising. Luna: So what gives? Why would a mega-cap tech stock rally when the discount rate goes up? Lucas: Because it's not just about rates, it's about earnings visibility. Microsoft's cloud and AI business is compounding at a pace that makes its valuation less sensitive to a fifty-basis-point move. The market is rewarding companies with durable cash flows and punishing those with more speculative futures. That's why small caps are down two point one percent — they're more levered to borrowing costs and have less margin of safety. Luna: So the takeaway is to lean into quality, but that feels a bit generic. What's the specific framework you'd use to adjust a portfolio right now? Lucas: I'd start with your required return. If the ten-year Treasury is yielding, say, four point five percent, your equity risk premium just got thinner. So as a stock picker, you need to demand a higher potential return from every company you buy. That means recalculating your hurdle rate for each stock on your watchlist. If a company's expected return over the next five years is less than two times the ten-year yield, it might not be worth the risk. Luna: That's a concrete rule of thumb. But doesn't that automatically disqualify a lot of high-growth names? They often have lower current earnings. Lucas: It does, and that's the point. You're not saying 'never buy growth,' you're saying 'price it correctly.' Microsoft can still clear that bar because its earnings are growing at twenty percent. But a speculative biotech with no revenue? That's a much harder sell in a rising rate environment. So the framework forces you to be honest about what you're buying. Luna: Okay, but what about the banks? They're flat this week, but they're clearly benefiting from higher rates. Is that a buy signal? Lucas: Not automatically. Bank stocks are also sensitive to the shape of the yield curve. If short-term rates rise faster than long-term rates, that can compress net interest margins. JPMorgan has been flat, but Bank of America is down half a percent. The market is telling you it's not a blanket move. You need to look at each bank's deposit base, loan mix, and capital levels. That's where the stock picker's edge comes in. Luna: So we're back to fundamentals. But there's a timing question here. The Fed might hike, or it might not. How do you avoid getting whipsawed by the headlines? Lucas: You can't avoid it entirely, but you can reduce it by focusing on the structural story. Take Chevron: it's up two percent this week because of a specific pipeline deal, not just because of oil prices. That's a company-specific catalyst. If you're buying a stock, you want to know exactly what has to go right for it to outperform, and whether that's independent of the next CPI print. Luna: That's a nice segue. We talk a lot about process here on the show, and it's part of why we can keep doing this without ads. If our conversations have helped you think about your own portfolio, a couple of dollars a month genuinely keeps us going — buy me a coffee dot com slash fexingo. It's a small way to say thanks, and it makes a real difference. Lucas: Yeah, we appreciate that. And it's not about perks or anything, it's just about keeping these episodes free for everyone. So, back to that process — I was reading your notes on how you'd actually apply this hurdle rate to a portfolio. You had a specific example with energy stocks. Luna: Right. So let's take Exxon versus Chevron. Exxon is down one point two percent this week, Chevron is up two point one. If you run the numbers, Chevron's free cash flow yield might be a full percentage point higher than Exxon's after adjusting for debt. That's the kind of gap that matters when rates are rising. Lucas: And that gap is exactly what a concentrated portfolio can exploit. Instead of owning ten energy stocks, you pick the one or two with the strongest balance sheets and the most visible catalysts. That's how you beat the index without taking on crazy risk. Luna: But isn't that just picking winners after the fact? I could see someone saying, 'Chevron went up, so now you're justifying it.' How do you know beforehand? Lucas: Fair challenge. The honest answer is you don't know for sure. But you can tilt the odds by looking at three things: the company's sensitivity to rates, its pricing power, and its capital allocation history. Chevron has been buying back stock aggressively and has a lower break-even price for its oil production. That gives it more cushion if the Fed goes too far. Luna: So it's about building a margin of safety into each position. That makes sense. But let's talk about the other end of the spectrum — those small caps that got hit this week. Is there any opportunity there, or should they stay on the bench for now? Lucas: There's always opportunity, but you need to be selective. The Russell 2000 is down two point one percent for the week, but that index is a mixed bag. Some small caps have minimal debt and high return on invested capital. Those are the ones you want to screen for. The problem is that in a rising rate environment, the market tends to sell all small caps indiscriminately. That creates mispricings. Luna: So you're saying there might be some bargains hiding in the rubble. Lucas: Exactly. But you have to be willing to do the work. Look for small caps with less than twenty percent debt to equity, positive free cash flow, and a product that's not discretionary. Those are the ones that can survive a downturn and come out stronger. I'd start there before venturing into the more speculative names. Luna: That's a solid checklist. Now, what about the dividend stocks? With rates rising, does that change their appeal? Lucas: It does. A dividend stock's yield is now competing directly with a risk-free Treasury. If a stock yields three percent and the ten-year is at four point five, you're taking on equity risk for less income. So you need to ask: is the dividend growing? If a company has a track record of raising its dividend by eight percent a year, the total return potential might still beat the bond. But if it's a static three percent yield, it's less compelling. Luna: So the growth of the dividend matters more than the yield itself. That's a good distinction. Lucas: Right. And that's why I'd look at companies with low payout ratios and strong cash flow. They have room to increase dividends over time. That's a different kind of growth stock, but it can be just as powerful in a portfolio. Luna: Let's bring it back to the current market. We have the S&P at 7,676, the Dow down, Nasdaq up. What's your read on the next few weeks for a stock picker? Lucas: I'd say stay nimble. The Fed decision is a big catalyst, but there's also earnings season coming up in October. Before that, you want to have your watchlist ready. If the market dips on a rate hike, you want to know exactly which stocks you'd buy and at what price. That's a discipline thing. Luna: So it's about preparation, not prediction. Lucas: Exactly. You can't predict the Fed, but you can prepare for any outcome. That's the edge a stock picker has over a passive index fund. You're not just taking whatever the market gives you – you're choosing your entry points. Luna: And if you're building a concentrated portfolio, that means maybe holding fewer names but being more certain about each one. Is that fair? Lucas: That's exactly the philosophy. Ten high-conviction names can outperform fifty vague ones, but only if you've done the homework. And in a rate-sensitive environment, that homework includes stress-testing your assumptions about how each company funds its growth. Luna: One thing I've noticed is that some big tech names like Apple and NVIDIA have been resilient. Apple is up one point three percent, NVIDIA up three point two. Does the rate framework apply there too? Lucas: It does, but their sensitivity is lower because they have massive cash reserves and pricing power. Apple can weather higher rates because it doesn't need to borrow for growth. NVIDIA is similar, though it trades at a much higher valuation. So you have to be careful: a high multiple can still be justified if earnings grow fast enough, but the margin for error is thinner. Luna: So what's your gut on NVIDIA at this level? It's up three percent this week, but is it still a buy? Lucas: I'd say it's a hold for now. The growth is real, but the stock price is pricing in perfection. If the Fed raises rates more than expected, even NVIDIA's valuation could take a hit. I'd wait for a pullback to add exposure, or start with a smaller position and average in. Luna: That makes sense. And for someone who's just starting to build a concentrated portfolio, what's the first step? Lucas: Start with your existing holdings and run them through the hurdle rate test. If you have a stock that doesn't clear the bar, ask yourself why you own it. That's the beginning of a more disciplined approach. Luna: That's a good practical takeaway. I also want to circle back to the Kalshi news – they're partnering with Alpaca to go international. Does that connect to stock picking at all, or is that more of a trading platform story? Lucas: It's tangential, but it's a reminder that alternative data and event-driven markets are becoming more accessible. For a stock picker, that means you can hedge or express views on macro events in ways you couldn't before. But it also adds complexity. I'd focus on getting the fundamentals right before dabbling in that. Luna: Agreed. But it's interesting to see how the landscape is evolving. Lucas: It is. And that's part of what makes stock picking so rewarding – it's a constantly shifting puzzle. The key is to stay grounded in the numbers and not get swept up in the noise. Luna: Well, I think we've given listeners a solid framework to think about their own portfolios. Any final thoughts before we wrap? Lucas: Just remember: the Fed is a backdrop, not the whole story. Great companies can outperform even in a rising rate environment, if you're selective. And if you're not sure, cash is a position too. Luna: That's a good note to end on. Thanks for the conversation, Lucas. Lucas: Always a pleasure, Luna.