by John Manley, Wells Fargo Asset Management
âWhat, me worry?â âAlfred E. Neuman, Mad Magazine
I think stocks may decline. I think interest rates may rise. I am not alone.
For the past several weeks, my mailbox has been inundated with calls for a correction. These are calls from reputable people who possess common sense and have a history of thoughtful predictions. They are not the letter-writing lunatic fringe who constantly perch on mountaintops or lounge on beaches, waiting for the end of life as we know it. These people and their opinions deserve respect.
Those calling for a correction are right about the direction but not so much the degree. I believe that the U.S. economy is improving and that improved conditions will soon allow Federal Reserve (Fed) Chair Janet Yellen to raise short-term interest rates. Chair Yellen is now alerting us to that possibility/probability. To me, this is an indication that she believes that the economy has improved enough to allow the Fed to raise rates without adversely affecting economic activity.
I agree with the conventional wisdom that interest rates are unnaturally low. They are low for a reason: to stimulate or at least nurture economic growth. When growth returns to more normal (higher) levels, so shall interest rates. The banks would like that, I would like that, andâunless youâre a homeowner who failed to lock in a mortgage at these ratesâyou should like it too. If I am right, higher rates will not be a call for economic and market destruction but rather a soft-spoken announcement that things are better.
Unfortunately, you have to get from here to there. As the probability of a rate hike occurring later this year increases, we will hear from the Cockroach School of rate forecasting, meaning âIf there is one, there must be many.â What, in reality, will be a long drawn-out process of normalization by the Fed will be characterized as a tightening. That characterization misses the point.
In my opinion, the Fed will not raise interest rates until it believes that higher rates will not adversely affect economic growth. Donât ask yourself how many times will the Fed raise rates in the next 12 months because itâs unknowable (if Chair Yellen doesnât know, how can you know?). Rather, ask yourself the proper question: âWill the Fed try to encourage or discourage growth in the next year?â
I may be wrong, but I simply canât see the latter happening. Too much money has been spent and too many rules have been bent to stifle the first signs of success. The Fed will nurture growth in the U.S. and seek to export it to our struggling friends around the world. That should mean the continuation of a positive monetary pressure environment for stocks, which can be viewed from a push and pull dynamic.
- Bull markets start with a push from the Fed, in that our central bank pushes money toward the U.S. economy by making money look cheap through interest-rate policy.
- Once the Fed gets the economy going and money is considered dear, it eases back on the pushing. Then, the money gets pulled in by the perception of opportunity for gain.
The latter hasnât happened ⊠yet. However, in between the Fed and the U.S. economy lie the capital markets. As long as the Fed pushes, I expect weâll get a net positive.
While this outcome may not be apparent for some time, if the stock market drops, it could be viewed as a buying opportunity. Bull markets end with enthusiasm, and enthusiasm needs an exclamation point. People get excited, and enthusiasm trumps concern. And people buy stocks to make money, not because they need yield.
The Moving Finger hasnât written that exclamation point yet, but I think it will before moving on.
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