The Federal Reserve recently announced it was raising the range of its federal funds rate, which, along with inflation, may be setting the stage for a stock market correction in 2016.
Recently, the Fed lowered its federal funds rate to between 0.25% and 0.50%—the first increase in nearly a decade and seven years after slashing it initially slashed the rate to zero. With better jobs data and low inflation, the Fed assures us that the U.S. economy is stable enough to withstand the rate hike.
However, the fact of the matter is that inflation is running at a much higher rate than what’s being reported, and rising interest rates will just cut into consumer spending and undermine an already fragile U.S. economy and stock market.
Does the Christmas Index Support Fed’s Claims?
The Federal Reserve raised interest rates a sliver on December 16, cautiously optimistic that the U.S. economy is healthy enough to stand, or at least start to stand, on its own two feet for the first time since the 2007–2009 financial crisis.
Unfortunately, rising interest rates have an adverse affect on consumer spending. As interest rates rise, consumer spending falls. That’s not great news for a nation that gets more than 70% of its gross domestic product (GDP) from consumer spending.
But the Fed tells us the economy is in check. According to the Bureau of Labor Statistics, the Consumer Price Index (CPI), the official measure of inflation in the U.S., rose a paltry 0.5% in the first 11 months of 2015. (Source: Bureau of Labor Statistics, last accessed December 16, 2015.)
Heck, even the Christmas Price Index (what it would cost to buy your immortal beloved each gift mentioned in the fetching holiday classic The 12 Days of Christmas) is up just 0.6%, or $198.00, at $34,130.99—or $155,407.18 if you count the cumulative cost of each gift repeated in the song. (Source: Christmas Price Index, last accessed December 23, 2015.)
But if you look at the numbers a little closer, you’ll see that everything isn’t as it appears. For example, in 2015, eight maids a milking was steady at $58.00. That’s not a big surprise, since the federal minimum wage hasn’t changed since 2009. The same goes for 11 pipers piping and 12 drummers drumming. It gets worse for nine ladies dancing, though; not only is their pay stagnant, but there’s not much demand for their craft either—a double-whammy hit.
So sure, on the surface, inflation is in check, but that’s because wages are flat. Unfortunately, we all know inflation is running at a much faster pace than 0.5% and the average American will not be able to afford the interest rate hikes. That bodes well for the stock market.
Federal Reserve Hiding Real Inflationary Data
The Federal Reserve’s rosy outlook on the U.S. economy overlooks the most basic items that everyone uses, including energy and food costs. I can’t imagine anyone cares about the 0.5% number when they know it excludes everything that matters on a day-to-day basis.
The Chapwood Index, which is an alternative non-government measure of inflation, tells a totally different story. The Chapwood Index looks at the unadjusted costs and price fluctuations of the top 500 items that we spend our money on in the 50 largest cities in the nation. (Source: Chapwood Index, last accessed December 23, 2015.)
For example, the index looks at the rising (or falling) costs of everyday items you and I might pay for, including “Advil,” a Starbucks coffee, gasoline, tolls, fast food meals, oil changes, car washes, cable TV and Internet service, dry cleaning, movie tickets, cosmetics, piano lessons, laundry detergent, light bulbs, school supplies, parking meters, pet food, and People magazine.
In 2014, the CPI rose 0.8%, but according to the Chapwood Index, major cities like New York, Los Angeles, Chicago, San Diego, and Boston saw inflation for the trailing 12 months (through to June of this year) run over 10%.
In San Jose, the Chapwood Index registered a 13.7% rise in the cost of living. Even Colorado Springs—the city with the lowest increase at 6.6%—was still 5.8% higher than the official CPI figure.
No matter what the official government data tells you, it’s a lot more expensive to live today.
S&P 500 Companies Feeling Weight of Stretched Consumers
The S&P 500 might be trading near record-highs, but the days of artificially low interest rates fuelling the stock market higher are coming to an end. Higher interest rates will hurt the average American consumer, which will hobble the revenue and earnings of those companies on the S&P 500.
Again, the S&P 500, while wobbly, is still near record-highs. Why? I’m not sure. In the fourth quarter, the estimated earnings decline is forecast at -4.5%—a significant revision over the -0.7% decline expected at the start of the fourth quarter (September 30). (Source: “Earnings Insight,” FactSet web site, December 18, 2015.)
For the fourth quarter of 2015, 84 companies (76%) have issued negative earnings-per-share (EPS) guidance. So far, only 26 companies have issued positive EPS guidance.
If the index reports a decline (of any size) in earnings in the fourth quarter, it will mark the first time the index has seen three consecutive quarters of year-over-year declines since the first quarter of 2009 to the third quarter of 2009.
For revenues, it’s even worse. The estimated revenue decline for the fourth quarter of 2015 is -3.1%. If this is the final revenue decline for the quarter, it will mark the first time the index has seen four consecutive quarters of year-over-year revenue declines since the fourth quarter of 2008 through the third quarter of 2009.
Looking ahead, optimistic analysts expect earnings growth to return in 2016. At some point, maybe. First-quarter results will be interesting. Will rising interest rates stretch the American consumer and curb revenue and earnings growth even further?
Or, put another way, will a tougher economic climate in the U.S. economy hurt American consumers even more? And will this negatively affect the stock market and potentially cause a major stock market correction in 2016? How can it not?