Ken Kam's Best Ideas Blog

The Federal Reserve cut interest rates last week and the market boomed. I did not foresee this outcome, and I’m still trying to understand the Fed’s thinking.

In the Strategy Lab Open competition, StocksRider pointed out that Wall Street and the media did a masterful job of painting a disaster if the Fed did not reduce rates. The Fed’s decision was not an easy one. I think dishwasher summed it up nicely as a tradeoff of style vs. principles.

But, now that the Fed has acted, it is more important to focus on the consequences of the Fed's action rather than the reasons. As Bobtheinvestor posted, “we have been dealt a deck of cards by the Fed - not exactly what we wanted but that does not mean that the world is over.”

The good news is that the immediate crisis looks to be over. Of course that was the intended effect. But in my experience, it’s the examination of the unintended consequences that often leads to good investment ideas.

For example, if other countries do not lower their interest rates, it is hard to escape the conclusion that the dollar is going to weaken – clearly an unintended consequence. In fact, during the past week, the dollar has set new lows against the euro, the Canadian dollar traded at parity to the U.S. dollar for the first time in over a decade, and the price of gold hit a 27 year high.

All else being equal, this improves the prospects for every other country relative to the U.S. making it important that we look globally for the best returns.

U.S. Global Investors (nasdaq: GROW) should benefit from this unintended consequence. U.S. Global runs many of the top-performing mutual funds over the past 5 years. GROW’s mutual funds invest in Eastern Europe, Emerging Markets and Natural Resources – all areas that should benefit from a weaker dollar.

The Fed is pushing the accelerator at a time when there is little slack in the economy. This means that another unintended consequence is that the shortage of refining capacity will get worse. This is good news for Valero (nyse: VLO), another one of my top holdings. Valero has suffered recently because Wall Street fanned the fear that a recession was just around the corner.

I see basically two ways that the refining capacity shortage can be resolved. Either new refineries are put online, or there is a recession. I don’t see any prospects for any new refineries to be put online in the next 2 years. I don’t even think the Federal and State agencies that would need to issue permits before construction would begin could act within a 2 year horizon. Therefore the only real threat I see to refining margins is a recession because that would reduce demand.

But with the Fed pressing on the economic accelerator, I think the chances of a recession have gone down. Valero has not fully recovered from the August correction. If I were not already fully invested, I would buy more.

Elan (nyse: ELN) is the other big position I have and I don’t think the Fed’s decision will have any impact on their future. Elan’s stock price is driven by sales of Tysabri, a multiple sclerosis drug. I don’t think any MS patients will change their treatment decisions one way or the other as a result of the Fed’s decision. After all, when you are sick, you want the best drug right now. You’re not going to wait until interest rates fall.

As with last week’s discussion on Apple, I'd like to invite you to join this discussion by posting your thoughts in a forum we've set up at Marketocracy. By sharing your insights hopefully we can make better decisions about how to respond to the Fed’s decision than we each would have made on our own. I will keep you updated as new posts add insights that affect my view.