FYI | Sep 07 2016
By Peter Switzer, Switzer Super Report
I don’t care when there’s a rate increase, it will be the same play
I seldom tip absolute certainties when it comes to stocks — I’ve been around long enough to be careful — but I feel comfortable telling you that when the Fed raises rates — be it September or December — the stock market will sell off. Frankly, I don’t care when it happens because my advice to you is bound to be the same — it’s just another buying opportunity.
The reaction to the slightly disappointing job numbers in the US for the month of August proves my point. Bad news for jobs was good news for stocks with the Dow Jones index up 72 points but this would have been reversed if the 200,000 jobs arrived instead of the 151,000 that showed up.
The first reaction to when the Fed is poised or actually does raise interest rates will lead to a sell off and I think the fact will bring a big sell off but it will only be a precursor to smarties saying: “Right, we’ve got that out of the system, so now it’s time to buy because the US economy is strong enough to need a rate rise.”
In fact, Barclays thinks the 151,000 was good enough to justify a September rate rise, with this note headed: “Labor markets squeak past threshold for September rate hike.”
Now they could only argue that if they think the US economy is delivering on its promise that it’s recovering. Goldman Sachs and bond guru, Bill Gross, think rates are set to rise this month, with the latter saying it is close to “100 per cent!”
The market bookies say the 26% chance of a rate hike this month is now 20% while December is priced at 50%.
My only interest in this Fed drama is for working out how we play this market. I have been saying that a market pullback was on the cards and we have dropped about 4.4% since the July highs, when 5600 briefly popped up on the S&P/ASX 200 index.
So, in many ways, a September rate rise might be more acceptable to give me the kind of oomph I’d like to see to help stocks power into a big finish for the year.
Here’s my alternative thinking.
The Fed surprises the majority by raising rates this month. The Richmond Federal Reserve Bank President Jeffrey Lacker says it should be on because employment growth is bigger than population growth and he thinks inflation is on the rise.
Against him, others point to the ISM manufacturing number, which wasn’t great.
The Wall Street Journal saw it this way: “The Institute for Supply Management’s index of manufacturing activity fell to 49.4 in August from 52.6 in July. A reading above 50 indicates factory activity is growing, while a reading under 50 signals contraction.
“The index over the past 12 month has averaged 50.2, a figure barely into expansion territory. The overall economy also has been growing only slowly, propped up by brisk consumer spending.”
And this is how Michael Gapen, chief U.S. economist at Barclays, viewed it: “The U.S. manufacturing sector remains in an extended period of stagnation following a modest improvement in recent months.”
Yet Barclays expects a September rate rise and that’s because other US economic data is actually pretty good and that’s why Jeffrey Lacker wants a rate rise and he wants it now.
Citi’s chief economist, Bill Lee, is punting on a December rise but he talked about concerns about “market distortions” on CNBC recently. That’s because interest rates have been so low for so long. Negative interest rates outside the US are good reason to worry about market distortions, which is typically characterised that bad news — lower job numbers — are good news for the stock market.
When that changes, the worst of the GFC black cloud will be blown away. I agree that the Fed will take this lower than expected jobs number to buy time and keep watching the data rollout and the US Presidential election in November, which should make it easier to act firmly in December.
As I’ve predicted, this would bring a sell off of stocks but I think the turnaround and buying could come more quickly, if the economic data is strong and Donald Trump isn’t leading the free world!
So should we expect a pullback sooner rather than later? I suspect so.
I see Wall Street determining our stock market future, as it often does.
It’s around all-time highs, which builds a case for a sell off. There are suggestions that future earnings could disappoint and we know stock market players get in early before reality comes along.
Julian Emanuel, executive director of US equity and derivatives strategy at UBS, thinks the US election could set the Yanks for a relief rally after a painfully long running of the Donald Trump show but earnings could be a problem. Despite market consensus backing a 12% rise in corporate earnings, “UBS is looking for something like 6%. There's an adjustment period between reconciling those two numbers. We think expectations are overly optimistic," he told CNBC.
If he’s right and analysts start believing he’s right, then a sell off could happen. On the other hand, if economic data is better than expected, then there could be an earnings upgrade so the only sell off could be linked to a rate rise in December. Then January would be a ripper month for stocks.
What could go wrong?
Weaker than expected US economic data is the big concern because that will say that quantitative easing hasn’t worked. I don’t want to contemplate that and you shouldn’t either, unless you’re shorting the market!
I’m working off no US recession for a couple of years and moderate gains for Wall Street, higher interest rates there and a lower dollar here, which will help our stock market.
I know there’s a lot of ‘ifs’ and ‘buts’ but this is the reality of climbing the wall of worry that all sustained rallies bring with it.
Right now, there are experts telling us to swap the reality of dividend-reliability for the hope of capital gain with growth or cyclical stocks but I recommend you keep a healthy respect for dividend stocks because I see interest rates staying low in Australia for some time.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
Content included in this article is not by association the view of FNArena (see our disclaimer).
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
