The big news last week focused almost exclusively on the changing interest rate policy following the low interest rates (monetary stimulus) that have been the driving force behind our economic and market recoveries in the years since the recession bottomed in 2009. With the new administration on its way to Washington, fiscal stimulus (government spending and tax cuts) will be the driving economic force as monetary stimulus begins to fade. The process of removing monetary stimulus took a big step forward last week as the Federal Reserve increased short-term interest rates by 0.25%.
The Fed is not taking the punch bowl away from the party just yet, but they are watering the punch down a bit. That is because these modestly higher rates are less stimulative for the economy.
HCM believes Wednesday's move is the first of many more to come. While last week’s increase was just the second in a decade, we believe the Fed will need to raise rates several times a year over the next few years, especially if the new administration is successful in moving forward with both infrastructure projects and tax cuts.
The stock market fell after the rate decision was announced last week as investors fretted over what the future path of rates might be. Rising rates challenge stock prices because the discount models used to value future earnings generate lower “fair values” as interest rates rise.
In time, HCM believes that rising rates will bring on the next market correction. However, with the major pieces of an economic stimulus plan falling into place, we believe the ultimate direction of policy is still likely to mean stronger growth, higher inflation, higher interest rates and improving economic fundamentals that will win the see-saw battle of equity prices for most of the next year, leading to higher stock prices and justifying our current overweight to stocks.
Stocks lost a little steam this week as the Fed’s rate increase weighed on the markets, with U.S. stocks (IWV – Russell 3000) losing about 0.28%. Developed foreign markets (EFA) joined the selloff losing about 0.57%. Emerging markets (EEM) with the pressure of a rising dollar lost about 2.43% for the week. Bonds (AGG), continued their slow grind down as they lost about 0.61% for the week. (Note: performance is based on the change in net asset value.)
Eye on the Week Ahead
Following the Fed's decision to raise interest rates for the first time in a year, several key economic reports are out this week that may shed some light on the direction of the economy moving forward. This week includes reports on the gross domestic product, durable goods orders, and consumer personal income and spending.
Key Dates/Data Releases
- 12/21: Existing home sales
- 12/22: Durable goods orders, GDP, income and outlays
- 12/23: New home sales, consumer sentiment
Weekly Focus – Think About It
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