Getting Ready To Rumble
“If it can’t be like before, I’ve got to let it end…maybe someday”. Maybe someday the economy will be like it was in the ‘70’s and the Fed will be increasing rates as inflation gyrates higher. Maybe someday the Fed will believe the economy can stand on its own two feet without the help of very easy monetary policies. That someday remains in the elusive future. While agreeing that the case for higher rates is actually strong, the Fed decided “to wait for further evidence of continued progress toward its objectives”. Never mind the economy, by many measures, is stronger today than when they raised last December. Three members strayed from the official statement and thought the time was right, however they will be off the voting committee soon, so maybe they were thumbing their nose? Surprisingly too was the pace of rate hikes and economic growth projections as they both slowed markedly from the Fed’s yearend projections. Economic growth is not to exceed 2% for the next two years, and it will take as long for the Fed to hike rates four more times. At least we know we’ll have a new President after the November elections. Given the choices, many would take a rate hike today and maybe someday elect someone new!
Of course the markets cheered the lower for longer mantra of the Fed. The easing policies from Japan didn’t hurt either. The Wednesday post Fed rally came of the highest volume of the week, but still well below levels reached the prior week when the markets were declining. We are in the middle of the roughest patch for stocks that ends mid-October. Historically, the markets make a bottom early in the third quarter and rally into the first quarter of the following year. With stocks near all-time highs and still easy monetary policies, it may not be too hard to believe the path of least resistance is higher into yearend. Yes, there is an election looming, however the markets have not changed long-term directions based upon who gets elected. The markets are rarely “surprised” by the outcome. But, we could see some softness over the next six weeks as the focus is likely to shift from the economy, monetary policy and earnings to who lives at the White House for the next four years. Much of the overall economic data we are reviewing is NOT pointing to a recession, so we are not expecting a lasting, large market decline for stocks in the near future. 3-5% declines are expected and perfectly normal over the coming weeks.
So much for higher interest rates! Once the announcement was made, bonds rallied across the yield curve as both short-term and long-term bond yields declined. In fact the bond model, after spending seven weeks projecting higher rates, turned and is now back on the lower for longer bandwagon. Yield differences between short and long-term rates remain fairly narrow, an indication of slower economic activity, but not yet recessionary. Inflation, as measured by various commodity indices point to modest inflation at best. Looking at the government figures for inflation, the two sectors showing the greatest prices gains are rents and medical costs. Both are not sensitive to higher interest rates. In fact, rents may actually rise faster if interest rates increase sometime in the future.
It has been feared that higher interest rates would push the dollar higher, thereby hurting businesses that import goods. Lower interest rates would do the opposite. However, we are seeing quite the opposite. The dollar rallied strongly from mid-’14 into early ’15 and has trended sideways over the past two years, even though the only rate increase was last December. The lack of direction in the dollar has allowed international investing to become popular again. Even weakness in Europe and questions about leadership from a variety of emerging markets has not dulled the returns from international investing. Just this quarter, broad international indices have doubled to tripled the returns of the SP500, even as the dollar remained stable during the quarter. Within the SP500, the more “risky” sectors, like technology have won the performance game, with the “safe” sectors like utilities and consumer staples, having a much rougher time. Investors are beginning to believe central bank “power” is waning and they may be unable to push rates higher anytime soon. So it is party on!
We got our relief rally as the Fed kept rates stable. Not only will we see more key economic data over the next two weeks, but earnings season will start up by mid-October. Both are likely to pale to the ramping up of the election rhetoric and focus on who will be the next President. We expect the markets to be volatile over the next few weeks, but we do not see a large market sell-off that could be a precursor to a recession. Slow economic growth, not a recession is our base case.
The opinions expressed in the Investment Newsletter are those of the author and is based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.