It’s all about the interest rates…

The markets waited all week last week for Friday’s release of the April non-farm payrolls report. After the underperformance of the March numbers, all eyes were on it to divine which way we were trending.

Rather than reiterate the numbers, here are news story headlines that came out about the same time the data did. “Jobs data ease rate hike fears.” “Goldilocks report.” “Good jobs report weak enough to hold off Fed.” “US stocks rising after a rebound in hiring last month bolstered optimism that economic growth is accelerating, but not fast enough to warrant higher interest rates in June.” And one more…”Probably best scenario in which the market was hoping for growth but not (so strong) that the Fed needs to hike in June…”

The stock market rallied nicely Friday after the report but not so much due to what the jobs numbers showed. As suggested in the “Goldilocks” comment, the report was strong enough to warrant faith in the ongoing recovery but not so good as to likely motivate the Fed to (finally) get started on raising interest rates soon.

Many are convinced that the market’s rise over the past 6 years has been primarily due to the ongoing easy money stance of the Federal Reserve. Therefore, I guess they think that the Fed raising rates would be the “end of the bull market.” In my view, that makes no sense whatever. After all, many of those same folks believed that the ending of quantitative easing would also start the market downhill. I hope the result will be similar!

Bond v. stock

Traders are also leery of rising rates as higher rates means more competition for stocks from bonds. The thinking goes that if I can get a predictable return of X from a bond that’s close to what I can make from a stock, with more price risk, then I may be more motivated to invest in bonds and take money from stocks.

That’s a legitimate issue – but certainly not for a very long time yet. The Fed has already said that, whenever they do start raising the rates, it won’t be a lot all at once. Think of their policy as becoming less loose – not tight. The time to actually be concerned about rising rates is when the Fed is actually tightening. By that I mean a period during which the short-term interest rates go up enough to either equal or even exceed long-term rates.

One indicator that’s used to quantify that is the relationship between the US Treasury 2 year and 10 year notes. Currently, with the 2 year around 0.60% and the 10 year at 2.29%, you can see that’s not a real concern right now.

Volatility is likely to rise

Over all the time I’ve been in this profession, I’ve come to believe that the markets are efficient. That is, the more widely a fear is discussed, the less likely it is to create a problem. Not only do markets have the chance to discount whatever the concerns are, they also have the chance to adapt. The saying is that the information is “in the price” or “in the market.”

In the case of the interest rates, the one known is that they’re rising. The uncertainty is around the amount and timing of them. Uncertainty is a big factor in the current trading environment. Right now, a lot of the recent price action in stocks has been driven by the traders buying and selling in order to better position themselves in the market. Just consider the price movements in oil, the dollar and the biotechs as examples. While I understand the reasoning behind these positioning-driven moves by traders, it makes absolutely zero sense to adjust any long-term portfolios based on these short-term moves.

Economic data and the Fed will continue to be in the spotlight. Continued improvement in the economic data will lead to both a Fed rate hike and increased stock price volatility in advance of any actual announcement – so be prepared for more flipping around as we move closer to the rate hike date.

In my view, September looks like the most likely time for an initial hike at this point, but that could certainly change…and create more volatility as a result.

Patience can be tough, but that’s definitely what’s needed in this transition period.

Cheers!

Mike

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

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