Second, the weaker the economic picture, the more likely the stock bull will prevail. In fact, the entire reason that the Federal Reserve needed to enact three rounds of electronic money creation via quantitative easing ($3.75 trillion in “QE”) on top of six-and-a-half years of zero percent overnight lending rates is because the economy has been too weak to tighten borrowing costs.
Ironically, Fed chairwoman Yellen maintains that she anticipates hiking rates some time in 2015. Even though annual economic growth throughout the recovery has been stuck near the 2% level? Even as the Fed has downgraded its own expectations for economic expansion for the seventh consecutive year? Even as the the Fed has overestimated the pace of expansion in each of the last seven years?
The bond market via the iShares 7-10 Year Treasury (IEF) is not entirely sure if overnight lending rates will be bumped up or not. The fact that the slope of the 50-day moving average has turned lower here in 2015 suggests higher yields in the future, in much the same way that the announcement of QE tapering sent bond yields skyrocketing in 2013. However, IEF’s higher lows over the past five weeks coupled with strong resistance for the 10-year yield near 2.5% may suggest otherwise.
Even more intriguing is the likelihood that the pace of any rate hikes may be more important than the timing of the first shot. September? Doubtful. December. Probably. Yet fed funds futures have only priced in a rate of 0.75% by the end of 2016. Only three rate hikes over the next 18 months? Or maybe it will be six at 0.125% so that the pace is even slower than the seemingly preordained quarter-point moves. (You heard the concept of one-eighth of a point here first!)
Impressively, stocks continue to benefit from every economic downgrade as well as the lowered expectations for the rate hike timeline. If the European Central Bank (ECB) in Europe can successfully kick Greek debt woes down the pathway – if Chinese authorities can successfully decree that “thou shalt buy-n-hold Shanghai shares” – U.S. stocks may not have much too fear. Indeed, the uptrends for core holdings like iShares S&P 100 (OEF), SPDR Select Sector Health Care (XLV) and Vanguard Information Technology (VGT) remain intact.
At the same time, we’re holding a larger-than-usual amount in cash/cash equivalents (15%) in most portfolios. Debt-fueled excess in Greece, Puerto Rico and China gave us a peek of the challenges that central banks around the world will be facing. Global economic deceleration and sky-high U.S. valuations are another. We anticipate an opportunity in the 2nd half of 2015 to buy quality assets at significantly lower prices.