See you in September?

While both the NASDAQ and Russell 2000 each made new all-time highs, about the only real news of interest to our markets this week came out on Wednesday when the Federal Reserve Open Market Committee (FOMC) released its notes from the latest meeting, along with Fed Chair Janet Yellen’s comments on those notes.

Legendary investor Peter Lynch once observed that, “If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 of them.” As an example, don’t feel badly if you can’t get a handle on all this rate timing business. The pros don’t get it either. Last year, all/each of the 67 so-called Fed-watching economists who create interest rate forecasts from the Fed data were unanimous that rates would rise.

Well, as you may recall, rates did exactly the opposite so even all the degrees and contacts in the known universe apparently aren’t helpful in figuring out this stuff. This seems to reinforce a quote from Dr. Lawrence Peter. The good doctor suggested that, “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.”

I agree with both gentlemen’s views, so let me save you some minutes with this synopsis…along with a few personal insights, to be sure.

What the Fed said (Reader’s Digest version)

In fact, they didn’t say much at all in terms of taking immediate action, relying on the “it’s dependent on the data”. They did upgrade their overall view of the US economy (“broadly improved”). However, they added that inflation and employment are “not quite at their stated targets.” However, on Thursday this week, a couple reports came out that seem to me to give the Fed the basis for going forward.

The most significant was that the May Consumer Price Index (CPI), which measures inflation at our level, had its biggest jump in about 2 years. The main reason is that oil and gasoline prices are starting to recover. In the past four months, the CPI has grown at a 3% annualized rate; that’s the fastest rate in three years. This isn’t just due to the recent move in energy prices. If you exclude the always volatile food and energy sectors, the CPI is up at 2.4% annualized rate over the same period. Either way you look at it, the recent pace of US inflation has been running above the Fed’s 2% target and could eventually put pressure on the Fed to raise rates faster than the market expects.

In addition, we saw the weekly initial unemployment claims fall again – and by more than expected. Matter of fact, the Labor Department (DOL) says that claims below 300,000 a week nationally is a level usually associated with a firming labor market. Better yet…the DOL tells us that we’ve now been below that level for 15 straight weeks.

I think the most important comment came from the Fed Chair, Janet Yellen, when she said at the press conference about the recent meeting, “Sometimes too much attention is placed on the timing of the first increase in the Federal Funds rate. What should matter is the trajectory.” In other words, it’ll happen when it does – just be aware of the speed at which we (the Fed) boost the rates.

What about the rates and market?

I think we’ll see the Fed begin raising rates in September. I say this because part of the info released by the Fed in the minutes was the latest version of their dot matrix. That’s basically a plot showing each of the FOMC members thinking as to where they believe rates are going and when. This matrix seems to suggest there could be as many as two one quarter of a percent rate hikes this year with a pattern of moving every other meeting in 2016 to add another one percent over the year.

JPMorgan Chief US Economist Michael Feroli said he believes that the Fed Funds rates will be even higher, “probably be more like 1.75 percent to 2 percent” by the end of 2016. It’s 0.00 to 0.25 percent today.

I believe quite strongly that any rate hikes in the next 12 months will not remotely even come close to derailing the economy. As I’ve stated many times before, the Fed will just be “less loose,” not “tight.”

The economy can handle higher rates as described here. The math of it is that if you consider what’s called the nominal Gross Domestic Product (GDP) – that’s real GDP growth plus inflation – we’ve had growth of 3.5% to 4%, on an annualized basis, for the past five years. This level suggests that monetary policy would be what’s called neutral. That means it’s consistent with generally stable prices. This would have that Fed Funds rate somewhat above 3%.

If that’s the math and the predictions are for some increases way less than that, seems pretty hard to see how higher rates will kill the bull.

Market response

More than a couple headlines have attributed the market’s rising this week to the “dovish” Fed. That means, rates didn’t go up so let’s buy more stocks.

My concern is that when the Fed actually does come close to raising rates, say in September, the traders and all those others who have never seen a stock market function when rates are moving up, will knee-jerk the markets and just flat sell. My advice for when/if that happens is to ignore the noise, stay with your strategy and wait for the adults to come out again.

Even if you were the one tea leaf reader who can consistently figure out the timing and amount of rate hikes, you still wouldn’t know how the markets will react so why worry about it???

Cheers!

Mike

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

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