Will a Return to Normalized Interest Rates Halt Economic Growth?
I really don’t expect the stock market to come apart unless there’s some sort of shock. Why? Because many blue chips are trading right around their historical valuations at this time. And with equities in consolidation mode until the next meeting of the Federal Reserve in September, there is not a lot of new action to take.
I have to admit that the stock market is holding up extremely well in the face of declining earnings expectations. Given the anemic rate of growth in the U.S. economy, the next recession is a real possibility within the next 18 months. The catalyst for a technical recession could be rising interest rates that, as we know, have been artificially low for a long time now.
But there are other pressures in the marketplace, too. The spot price of oil is surprisingly strong, given the economic outlook. Some precious metals have also been ticking higher recently. But while there is price inflation in the general economy, it doesn’t show in the headline numbers and it isn’t translating into new spending by corporations. (Many companies experienced revenue growth in the second quarter solely due to increased prices for their products, not increased volume.)
Corporations and individuals continue to be highly conservative with their spending. This is a positive development as corporate and individual balance sheets improve, but it doesn’t help a consumption-based economy.
I continue to believe that this year’s stock market winners will remain that way. Institutional investors want reliability in earnings results, and they want the dividends that blue chips provide. There is not a lot of reliable growth out there, so when a company like Johnson & Johnson (JNJ) generates eight-percent top-line growth in one quarter, the stock market loads up.
You can tell by the most recent numbers that corporations have pretty much exhausted their abilities to grow their bottom lines on cost control alone. Meaningful revenue growth is a must if earnings are to grow at a rate greater than inflation going forward.
So all in all, the stock market is a big hold, but there are clouds on the horizon. Dividend income remains a top priority as far as I’m concerned; it’s probably the greatest certainty that a stock market investor has in the current environment.
Interest rates are too low and the marketplace is chomping at the bit to see the entire yield curve move upward. And while it’s correct to have the Federal Reserve out of the bond market, a return to a more normal interest rate environment may turn out to be the catalyst for even slower growth. (See “Why You Should Listen to This Micro-Cap Company.”)
The cycle will play itself out, and there’s no reason to be in a rush to consider new positions in this stock market. I wouldn’t be adding to existing blue chips; rather, I’d be keeping any new monies in cash for the time being. I really don’t expect anything significant from the stock market until the next Fed meeting.