For those who believe the extraordinary rise in stocks that we’ve witnessed since March 2009 is coming to an end, particularly in light on an impending interest rate hike, here are statistics that may prove otherwise.
Take a look at the following chart, one that I shared with my clients back in late May. (click on graphic to expand it)
The point — Don’t fear the Fed or let fear of an interest rate hike affect your equity allocation, barring other circumstances. The anticipation of a rate hike by investors is more apt to cause a short-term correction not the actual event. After all, doesn’t a rate hike signal that the economy is on the path to recovery?
On Wednesday, September 17th, the Federal Reserve wrapped up its Federal Open Market Committee (FOMC) meeting, keeping interest rates near zero. The Federal Reserve left its vague considerable time phrase in their meeting notes, specifically stating, “It likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends.”
The Quantitative Easing bond buying program will likely conclude next month so the countdown to the first hike of the federal funds rate (cost of overnight loans between banks) begins. I calculate considerable time to mean 5, 6 or 7 months out. It is with almost certainty now that by mid-year 2015 the Fed is going to start normalizing the federal funds rate, taking it from a target range of 0% – 0.25% to possibly 1.5% in 2015 and 3.0% in 2016. While this may seem like a dramatic move, these interest rate levels are considerably lower than where rates were prior to the Great Recession (6.25% in August 2007, for example). The Fed has been providing unprecedented easing for the past 6 years; now that’s what I call considerable time.
As Adam Posen, president of the Peterson Institute of International Economics, stated earlier in the week “it’s just a rate hike. I think liftoff is going to be the Y2K of 2015, it is going to be much hyped and then turn out to be just every day. Liftoff is going to be a non-event and it will accurately reflect the fact that Chair Yellen and the FOMC care about inflation.”
Where there could be some worry is with income generating securities such as bonds. We witnessed this in the summer of 2014 during the travails of the taper tantrum when Fed Chairman Bernanke announced the Fed would soon begin winding up its Quantitative Easing program, which is finally close at hand. Investors must be cognizant of their duration risk, or the sensitivity of the price of a bond to changes in interest rates. Additionally, for international investments, one may look to hedge or mitigate the impact of currency movements on returns. And, one must be aware of perverse currency carry trade effects that may result from a strengthening US dollar.
For now, the Fed’s zero interest rate policy (ZIRP) is baiting investors to stay the course with what’s been working. The Great Recession’s unconventional Fed policies are being sopped up and we’re normalizing to traditional Federal Reserve action.
For now, it’s steady as we go; interest rates won’t rise until springtime given slow moving economic growth and a dearth of fiscal stimulus. I remain optimistic that better days are ahead of us. Maybe we’re 2 or 3 years out before the economic and credit cycle turns against us, so until then party like it’s 1999 as Prince sang (forgoing Y2K concerns) and let go of any impending rate hike fears.