Doubt about the U.S. economy’s ability to sustain itself without Federal Reserve rate manipulation, as well as lack of confidence in the ability for U.S. companies to generate profits and revenue in the current environment, go a long way towards explaining why longer-term treasury bonds are outperforming stocks. Even if investors convince themselves that the Fed will not raise borrowing costs at any point in 2015, public companies may fail to hurdle a very low bar. Flat profits and flat revenue may be enough to keep stocks range-bound, but earnings and sales declines might send stocks for a tumble. (And then what would the Fed do… hint at the possibility of QE4?)
I may be discussing QE4 in jest, but there are very real risks in the slightest move toward raising benchmark borrowing costs. How does one know? The Credit Managers Index (CMI) via the National Association of Credit Managers recently demonstrated extraordinary stress in the amount of credit being extended to businesses (or lack thereof) as well as the number of rejected credit applications. Below is the CMI in chart form, care of Alexander Giryavets at Advisor Perspectives. One may wish to compare what happened to CMI in 2007 prior the recession and what may be transpiring today.
In my estimation, the Fed is aware just how tenuous its grip is on lending activity. If the extension of credit is declining at a rapid clip on the mere suggestion that the Fed wishes to normalize borrowing costs, how bad will the credit crunch be if the Fed actually begins a rate hike campaign in earnest?
Throughout the year, I have suggested that the Fed will get no farther than a token 0.25% hike in the overnight lending rate in 2015, and they may only do so to save face. The economic data itself will not support more. In fact, the data may suggest more accommodation, not less, before the year is out. However, the Bernanke/Yellen Federal Reserve tends to make conciliatory comments only after equity sell-offs approach key percentage levels (e.g., 10% level for October’s “Bullard bounce,” 20% during euro-zone crisis, etc.). In other words, those who are counting on a Fed rescue might not get words of comfort and assurance unless the S&P 500 approaches 1900.
Stick with the barbell. Specifically, hold onto those stock ETFs with price momentum and technical uptrends, including SPDR Select Health Care (XLV), Vanguard Mid Cap Value (VOE) and iShares Currency Hedged Germany (HEWG). Offset your equity exposure with long-term treasuries via ETFs like iShares 20+ Year Treasury (TLT) and closed-end muni funds like Blackrock Muni Assets (MUA).
