Weekly Nolte Notes
To no one’s surprise, the Fed increased interest rates last week. To the surprise of many, the markets rallied following the decision, due to the thought that they were not going to be aggressively raising rates this year. Indeed, they did not increase their estimates of economic growth and inflation is near their 2% target. Additionally, they feel employment should remain steady not increasing, nor decreasing from current levels. This is what nirvana looks like! Their projections for economic growth are well below that of the White House and holding steady for the next two years. If all is so rosy, why then raise rates? Could it be that they are really watching the financial markets and worried about stocks getting way ahead of their reality? Do they see stocks as “bubbly” and wishing to remove some of the froth? We won’t know for a few months, but the Fed’s hope is that the very optimistic views of both consumers and industry begins to translate to real economic activity rather than just a “good feeling.” We might get some insights this week as various Fed officials will once again be on the speaking circuit. Housing data will be the “big” economic data for the week.
After a bit more than a week resting, the stock market once again turned higher, rallying following the Fed meeting. Some of the bullish views of various market participants have waned as the SP500 has traded interestingly sideways over the past month. The market internals are also declining a bit, but remain comfortably in “uptrend” territory. As we have maintained for a while, the markets can rally for a bit as investors embrace the “new” economic policies and promises of better economic conditions. However, as we are beginning to see, the sledding could be getting difficult for the legislative process and promised tax cuts could be pushed out much later than originally thought. If the markets have been rallying on the thought of higher economic growth and lower taxes any hiccups along the way could be met with selling pressure. The markets for the long-term remain richly valued. Unlike past periods of overvaluation, today we are seeing extended valuations in many different asset classes and industry groups within the SP500. When the markets finally do turn, hiding places within the stock market may be rather paltry. Timing of the turn, which is ALWAYS the big question, remains elusive and in the words of the Supreme Court, we’ll know it when we see it!
It is not just the Fed that is getting bullish about economic conditions, as global central banks are beginning to make rumblings about reducing the amount of quantitative easing (QE) and maybe even increasing their rates. That remains “out there” and is not likely to occur very soon, but the path is being prepared. Much has been made about inflation and expectations with the Fed increase in rates. However, oil prices have broken below $50/barrel as production cuts are difficult to maintain. Inflation rates remain well above short-term rates and could provide additional reasons for the Fed to hike in the months ahead. If history is any indication, the smooth glide path outlined at this Fed meeting is not a likely outcome the remainder of the year.
Looking at the various asset classes as well as industry groups has been instructive in picking out changes in some very long trends. First up are the international markets, specifically emerging markets. Over the past seven years, emerging markets have trended sideways, meaning they have lost the performance game to the SP500. However, starting early last year, emerging markets began to outperform and have recently broken that longterm decline vs. the SP500. Many would note the dollar is strong, we are raising rates and commodities are weak so investing in emerging markets is a fool’s errand. We would note that valuations are much lower and economic growth rates higher than in the US. They are not as dependent upon commodities as in the past and the dollar has traded within a sideways band for the past two years. Developed international markets are about two years behind emerging markets, having suffered through eight years of relative poor performance to the SP500. They may be in the early phases of bottoming, however that may take some time to develop.
After slowly starting out the month, international investing is once again taking the lead, with emerging markets rising nearly 4% last week and 12% this year. After performing very poorly relative to US stocks, we believe international investing may provide the best equity returns in the years ahead. Bond investors should hold relatively short term maturities as expectations for higher rates remain in place.
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.