It is hard to argue why the Fed is raising rates at this point in time. The economy has strengthened to a level where zero interest rates are not necessary. This is not to say the economy is completely out of the woods; interest rates still remain highly accommodative and nowhere near a “normal” rate which we estimate to be around 2-3%. The Fed continued to make similar dovish comments today. They indicate that they will gradually raise rates and wait for additional data on the economy before taking additional action. “Gradual” was so important, it was mentioned twice in the Fed’s press release after their meeting. Fed Tightens
As we enter a new interest rate cycle, what does this mean for the market? Contrary to conventional wisdom, rising interest rates seldom spell doom for the markets. In fact, during past periods of Fed rate hike cycles since 1983, the market has actually been rising, returning an average of almost 10% (Source 1). While that might be optimistic, we also don’t see the U.S. heading towards another recession like Europe in 2011 after the European Central Bank raised rates and quashed a weak recovery. Currently we don’t see any indicators that point to a recession: recent manufacturing data has slowed but nowhere near recessions levels, profit growth outside the energy sector has been resilient, and most importantly, the Treasury yield curve remains positive. The Treasury yield curve has been one of the best indicators for the economy. History shows that when longer term Treasury bonds yields are LOWER than shorter term bonds yields (the green circles), a recession came shortly after (the grey bars). Even if the yield curve were to flatten by 0.25%, the chart below still shows the bond market is not indicating an upcoming recession.
We continue to be modestly optimistic about the next 12 months. However we will monitor the data carefully. If the problems get worse, we will take action. Most of Apriems’ strategies now include a circuit breaker component in our investment process. If our thesis on the market is wrong, this type circuit breaker allows us to reduce risk in client portfolios to try to preserve your capital. We continue to review our process to determine if adjustments are needed as we go forward. We know that you have placed significant trust in our team at Apriem. We do not take this responsibility lightly.
-The Apriem Investment Team-