Change is in the air, and it’s happening all around. There is growing expectation that both the Bank of England and the European Central Bank will soon raise their benchmark interest rates. The inflation rate in the U.K. just hit 4.4% in February, which is more than double the central bank’s annualized target of two percent. Higher oil prices aren’t helping the situation and you can bet that, over the coming quarters, there will be increasing pressure on central banks around the world to raise interest rates. The interest rate cycle has already begun to reverse.
In almost all occasions, higher interest rates for borrowing don’t help the economy. In this particular situation, however, increased rates won’t necessarily hurt economic growth. Because we’re coming from a base of rates at record lows, businesses and consumers can handle an increase of point or two. A modest rise in short-term interest rates isn’t going to hurt an already lackluster housing market.
The other big change that’s in the air for investors is the upcoming earnings reporting season. Because of the shocks from Japan and Libya, the market hasn’t run up in anticipation of the numbers. I think we’re going to get strong earnings, especially from large corporations that continue to increase their selling prices. This pricing action goes right to the bottom line and all indications are for a strong first quarter.
If you think about all the shocks that financial markets have had to deal with over the last few months, you might agree with me that equities have held up exceptionally well. The one thing that investors don’t like is uncertainty. So far this year, we’ve had a regime change in Egypt, major civil protests in other big oil-producing countries, battles in Libya, record-high prices for food and precious metals, and a catastrophic earthquake in the world’s third largest economy. Yet, the S&P 500 Index is only about 45 points from its 52-week and three-year highs. This to me is exceptional, and it makes me think that stock prices could go a lot higher this year.
Goldman Sachs is predicting that the world economy will grow by about 4.8% this year. JPMorgan Chase expects 4.4%. According to Bloomberg, the average global growth rate over the last 20 years is around 3.4%.
Now, as we all know from history, economic booms (in Western countries) tend to follow cataclysmic events like war and natural disasters. As the world’s third largest economy, Japan has to engage in a multi-year rebuild that will be the cause of much higher than normal domestic economic stimulus. This unforeseen economic spending could have quite a positive effect on the global economy (lumber stocks remain strong) and will only add to overall growth rates.
So, from my perspective, the outlook for both the domestic economy and the stock market continues to improve. The one certainty I do know going forward is that there will be increasing pressure on interest rates. Right now, the stock market and the economy can handle this eventuality.