Here comes the Fed!

It may seem like forever ago, but, in fact, it was less than two months ago, the WSJ (Wall Street Journal) wrote, “It’s Official: This Is the Most Boring Stock Market in Decades.” And it definitely was. The folk at S&P say that the S&P 500 traded in a very narrow 110-point range between 2020 and 2130 going back to the beginning of February through the middle of August. That was highly unusual.

Then, we all got onto the volatility train and have since taken a trip to Correction Land, where the daily market changes have led to all kinds of heavy breathing, along with wailing and gnashing, for seemingly most financial media reports. A 10% drop after running up over 200% doesn’t seem to warrant such wild responses. (I agree with Ben Carlson’s definition of a market correction. He describes one as something everyone says is going to be healthy before it happens…until it does. At that point, however, it somehow morphs into a disaster that will “never end…”)

We can also see that volatility works both ways as this past week was the best week for the Dow since 20 March and for both the S&P500 and the NASDAQ, the best week since 17 July, so it’s not all really doom and gloom. It’s a pretty typical market correction action…and, unlike those downward fluxes, these upward bumps typically create very few expressions of concern.

I firmly believe that, comments about oil and China aside, what’s been stirring up the markets is primarily a reflection of widespread uncertainty about interest rates. Not so much the timing of when the Fed may begin doing so – its first opportunity will be the middle of this week – and not even the amount, as most expect a “rise” of 25 basis points, aka, one-quarter of one percent.

Why or how can such a ridiculously small increase be at the heart of all this confusion, as well as being the object of such concern and confusion? One word. Uncertainty. And markets hate/detest/can’t function well in uncertainty.

Why the uncertainty?

First, it’s not exactly top secret that most individual investors, institutional investors, hedge funds and even – and especially – Wall Street strategists have never fully bought into – literally or figuratively – US stocks during this entire bull market. So, any change in the status quo seems to be grounds for running out the lifeboats. Many believe our stock market is extremely overvalued. One reason why it’s hard for me to accept that is, in large part, simply because the prevailing sentiment has been, and remains, very skeptical. No market tops I’ve ever participated in or read about have occurred in circumstances like these.

Next, a WSJ survey of private and academic economists released Friday shows just a slight majority thinking there will be no increase announced at this Fed meeting so if even professionals looking at the same data can’t come to a consensus…how can an individual investor?

Finally, this will be – whenever it ultimately happens – the very first time in about 11 years that the Fed has raised rates. That fact alone is angst-inducing for many. As a result, the market’s reaction to any tightening is more unpredictable than it has ever been; a fact likely to increase anxiety and uncertainty throughout the cycle.

Add to this the fact that the vast majority of all market participants of whatever level have never, ever been in a trading environment in which interest rates are actually rising – forget by what increments. With US interest rates never having been this low, for this long, what happens with the turning of that trend is apparently creating a string of Maalox moments for participants.

What happens with/to the markets when they do raise rates?

As I’ve said many times since the Fed first started backing away from its easy money policy, there still could be quite a negative market response – even though this has be a prime topic for almost a year. So, if the market does go all squirrely, to paraphrase the “Wizard of Oz”, pay no attention to the people behind the curtain. This has, in fact, all happened before.

What we’re doing is simply moving back to a much more normal rate environment. This normalization in monetary policy is unlikely to be any preview of bad things to come. Higher rates typically occur in times of stronger economies. Over my career, stocks haven’t had much trouble with competition from bonds until rates get up closer to 4% – they’re, effectively, at zero right now. That’s a really, really long way away in bond rates…

I don’t think the market participants realize that the Fed could hike once or twice…and then do nothing else for a while. Seems to me it’s all about how any increase affects investor psychology. But, come on, in reality, 0.25% increases aren’t that much…like a no meaningful figure type increase.

Historically, if there’s a selloff subsequent to an initial rate hike, stocks recover and begin to again move higher. No firm idea as to the timing because, whether it’s rates or prices or trends, there are no certainties in the markets. Otherwise there would be no risk and, therefore, no rewards of note.

Summary

Don’t worry about rate hikes – they’ve happened before and will definitely happen again. If the Fed elects to delay this first shot, no big deal…but, in my opinion, neither is it a big deal if they don’t.

Remember, too that uncertainty equals opportunity. Don’t fear the Fed. Focus on the companies. They’re still making or doing whatever it is that they’ve been doing every day…it’s just that the share or unit prices have currently been adjusted lower to make high-quality companies and funds more attractive.

One last bit of guidance, courtesy of Jason Zweig. He believes that, regarding markets, anything is possible and the unexpected is inevitable. Proceed accordingly…

Cheers!

Mike

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

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