Summary of «The Main Event»
The Fed will soon begin to finally raise interest rates for the first time in this recovery. Perhaps, as the Fed regularly advertises and as many investors anticipate, the “main event” will pass with little fanfare or consequence for the financial markets. However, we suggest caution and suspect additional stock market turbulence and maybe a correction is yet forthcoming.
The stock market has usually suffered at least a period of flatness in the year following an initial Fed tightening. Moreover, the environment surrounding the stock market in this recovery appears much more vulnerable compared to past recoveries when the Fed was nearing its first tightening move.
Valuations in the current stock market are more extended, the stock market has not experienced much turbulence in recent years, the economy has already returned to near full employment, and the earnings cycle (both profit margins and earnings growth) is much more mature and far past its best performance.
We are in the “mother” of all U.S. monetary easing cycles. The financial markets have been supported throughout this recovery by a massive and unconventional monetary policy. It seems a bit unrealistic to expect the stock market to simply skate right through as the Fed finally attempts to turn the monetary boat for the first time in this unprecedented monetary cycle. Perhaps, the stock market will surprise and continue to zoom ahead even as the Fed finally begins to normalize policy. However, the stock market has trended mainly sideways ever since the Fed stopped adding to quantitative easing last year. And, it does not seem unreasonable for the stock market to struggle even more, at least for a time, with the first rise in short-term interest rates in almost a decade.
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by James W. Paulsen, Ph.D
Chief Investment Strategist
Wells Capital Management, Inc.