Sunday, December 18, 2016

Stock Market: Relax, The Fed Won`t Stop The Rally

(Drivebycuriosity) - Finally, last week the Fed hiked her interest rates, the second raise since the recession 2008.  The step was generally expected and already priced into stock & bond prices. But the Fed also suggested that they might raise their interest rates 3-times next year which might have caught some observers by surprise. Now the markets are digesting the interest rate projection.

I think that last week´s hike - and the projected lifts for next year - are just responses to the better prospects for the global economy. The news from the economic front signal that economies in the US, China  & Europe are getting better (calculatedrisk  driveby). The current rally on the stock markets is happening for the same reason.

We are seeing just a normalization. Interest rates have been ridiculous low - close to zero and in some areas below zero. This fits to an economic apocalypse but not to an economy which is gaining strength, albeit slowly. Interest rates have to go up, but not much because there inflation is still moderate and we are far away from an overheating economy.
I believe that the current stock market rally will continue in 2017 - even if the Fed indeed will hike three times. History shows that stock prices & interest rates can happily rise together: The Bank of America Merrill Lynch (finance) notices that “the 1950s was a period of higher stock prices and higher US interest rates. The US 10-year yield bottomed near 1.5% in late 1945 and the S&P 500 remained firmly within its secular bull market until yields moved to 5-6% in the mid 1960s. The S&P 500 rallied 460% over this period.”

I think we can have a similar development next year. Companies will benefit from a growing global economy and will sell more products which will translate into higher profits.  Helpful are the ongoing efficiency gains (due to learning & technological advance) and the growth of the emerging markets (China, India & Co). Therefore the profit gains will overcompensate the negative effect of the rising interest rates and the stock market rally will continue.

If Trump doesn`t start a trade war with China he might give the economy an additional boost by reducing taxes & regulation and infrastructure investments. This would also lift the interest rates on the bond market (the raise had already started). Then the projected interest rates hikes by the Fed would just follow the climbing market rates. As long the economy doesn`t overheat - and inflation doesn´t break out - the Fed policy will be no problem for the stock market. Relax.

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