Well, for the east coast, it was a wonderful spring weekend. I think I heard a few months back that the eastern U.S. could experience lower temperatures and more rainfall as a result of global warming, one possible outcome anyway. That’s not what I want to discuss but possibly the weather is as difficult to forecast as the stock market.
Lower inflation is potentially a larger threat to the U.S. economy than rising prices, according to Janet Yellen in her speech earlier this month. Easy money (Fed Monetary Policy) has been around for longer than it has in past recessions. If the past is an indication of the future, has the Fed again waited too long to act? Looking at the below chart, the dotted blue line illustrates the Fed Funds rate, registering near zero since 2008 while the grey areas represent recession periods. While I think it would not be fair to expect a smoother line, it does appear that the Fed is benefiting corporate America by keeping rates lower, which enables them to finance or refinance debt at historically low rates. Corporate profits have not suffered and the red S&P 500 line seems to indicate full speed ahead, being the leading indicator it is.
To be fair, Janet Yellen did mention “we’ll need to tighten policy to avoid overshooting our target.” She continued, saying, “Overshooting that goal, we have learned in past episodes, can be very costly to reverse.” So, is this an atypical recovery? Sure it is. Maybe rates needed to stay lower for longer, but the signs sure seem to be mounting that an easy monetary policy should soon be coming to an end. Indications are that the Fed will act gradually, smaller rate increases to ward off inflationary trends above the 2% target. Additionally, there hasn’t been much noise about the tapering of asset purchases but this is definitely the first step in removing some of the liquidity.
As for forecasting interest rates, the peak of the bell curve seems to be 3.40% for the 10-year yield, end of year 2014. The lowest forecast was 2.80%. The highest forecast was 4% shared by two firms.
Other evidence also supports the current bull market. The headwind from consumer deleveraging is behind us. The Eurozone recovery has an increasingly stronger foundation. Housing prices are rising, helping to boost consumer confidence. The impacts of the manufacturing and energy renaissances are broadening. Lastly, the severe weather for most of us anyway, seems to have abated.
Notice that we do not see periods of decline affiliated with initial increases in the Fed Funds rate. While we are seeing more volatility this year, there is no indication a market top is near. In fact, some of the economists research we see, points to pent up demand impacting numbers into the next couple of months. This could add to the upside surprise. Some of this can already be seen in the auto sales, which have languished for three months, falling by 6%. March auto sales however rebounded by 7% to a new seven year high at 16.33 million annualized. I think that may be directly linked to weather more than any other economic number. We’ll see how employment fairs!
As for earnings season updates, about 60% of the S&P 500 have reported so far. Consensus expectations have gone from marginally negative growth to marginally positive growth, around 2% year over year. 54% have beaten on EPS, 49% have beaten on sales and 33% have beaten on both.
Lower rates for a longer period have apparently helped our U.S. companies and stock market to get a strong boost forward. Lower energy prices could also provide some tailwind but they have remained relatively high with the weather and Ukraine crisis. Capital Expenditures have recently ticked up and as companies spend, we should begin to see what history has shown, the Fed beginning to tighten!
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