As a result, there’s a new perception that the Fed will react sooner by raising rates this summer and that excess market liquidity will ebb, interest rates will rise, the dollar will stay strong, earnings will disappoint and the financial markets will be under pressure. All of this happened in one day, based on one data point out of many that the Fed considers while deciding on its rate policies.
I disagree!
While employment rose by 295,000 jobs in February (January was revised down), hourly earnings rose a disappointing 0.1 percent, productivity declined and the labor participation rate fell to 62.9 percent. I still believe that the reality is different than the perception. The Fed will err on the side of caution and delay its first-rate increase until there are signs of improving growth overseas, a change in inflationary expectations and sustainable increases in hourly income. It’s hard to imagine that the Fed would begin raising rates as commodity prices hit new lows and the dollar new highs. The first Fed funds increase most likely won’t happen until later in the year.
So where does this leave us?
I commented last week that I would expect the financial markets to have a knee-jerk reaction and decline initially after the first Fed funds rate increase. I guess that I should have said after the perception of the first rate increase. The Fed considers many variables or data points before formulating its policy. I continue to believe that it is premature for the Fed to begin raising rates.
Let’s assume that I am wrong and the Fed moves earlier than I think. What does that mean for asset allocation and investing? First of all, it would mean that the Fed sees the economy and financial markets both here and abroad as being in good shape with mitigated risk to the global financial system. (All the banks passed the Dodd Frank annual stress tests last week.)
While the markets may say that this is the beginning of the end for the financial markets, the correct question is whether this is the beginning of a very slow process and whether the Fed will maintain a prudent policy of increasing rates slowing only as the data points dictate. I continue to believe that the economic recovery here and abroad will be slower than normal but will extend longer than usual. All good, as pressures that tend to be precursors to the beginning of the next downturn will build more slowly than normal.
My asset allocation and portfolio structure remains unaltered. If anything, I am gaining more confidence that the global economies are at an inflection point: The economies will recover slower, but will extend further than in the past; interest rates pressures will stay muted; the dollar will remain the currency of choice until growth overseas is more prevalent; commodity prices will remain weak until supply and demand get into better balance; and corporate earnings, cash flow and free cash flow will surprise on the upside.
Invest in companies creating their own destiny and going through positive change. Short those companies where managements’ have their heads in the ground and don’t see the need to change to compete in a global economy.
I cannot stress enough the need for a global perspective. All markets are interdependent: If there is a cold anywhere, it affects everyone. Most times, the perception is not the reality. Maintain liquidity to take advantage of days like Friday and remember to review the facts, step back, reflect and … invest accordingly.