Accelerating or Decelerating
The Federal Reserve ended Quantitative Easing last fall and since then they have tried to prepare investors to expect interest rate increases this year. While the debate rages on the broader effect of QE on the economy, it was clearly responsible for putting a reliable lid on stock market volatility.
Believe it or not (and we don’t) the Fed’s reasoning for raising rates is based on their observation that the economy is accelerating rapidly enough that higher rates are needed to stave off inflation pressures. The Feds flirtation with rate increases was a primary factor in the massive rally in the US dollar/decline in the Euro since August:
Euro US Dollar
Earnings are the Focus
Without Fed intervention investors are finally shifting their focus back to market fundamentals. A string of macro-economic data points in the last three months is stirring concern about stock prices and valuations. The most concerning news is the dramatic decline in earnings expectations for the first three months of 2015
Reduced earnings expectations have brought renewed concern about corporate profitability as well.
As expectations are reduced, companies are getting their excuses in line. Unlike last year when weather was the go-to excuse for poor results, the strong dollar will be the primary scapegoat in 2015.
Corporate profits as a percentage of the overall economy are at the extremes of historical relationships. This heightens investors’ attention
The consensus is building that the economy must pick up steam to justify both current prices and further gains in domestic stocks. The problem for growth going forward is that the market no longer has billions of dollars in Fed stimulus greasing the economic skids each month. Even if the Fed surprised investors with another round of QE it did little to stimulate the main street economy. The turnover of dollars in our economy is actually less stimulative now than after the recession ended.
Transportation stocks are a reliable barometer of economic trends and the Dow Transports Index has diverged negatively from the S&P 500.
Poor first quarter earnings and weak leadership from transports help explain why the S&P is stalling out in 2015.
Forecasters now expect the Federal Reserve to wait until later in 2015 to raise rates instead of the mid-year. So, investors and the Fed are waiting for a clearer picture of economic activity to emerge from spring. Clarity will determine if an aging bull market will make it 7 years in a row.
In the meantime, the risk of a mild market correction boiling over into something more aggressive grows as investors that relied on leverage to boost their returns become impatient.
The dollar rally created several compelling investment opportunities that look like a promising alternative to the earnings issues in our domestic economy. Relative to the S&P 500 global markets have underperformed for years.
As the Fed ended QE here the European Central Bank started QE in Europe. Already low interest rates there have turned negative.
Foreign markets have outperformed the S&P 500 in 2015
The US is six years into a bull market without the Fed stabilizing demand. The consensus view is that domestic earnings will disappoint. The silver lining is that the dollar rally has muted economic activity to the point that the Fed will postpone rate increases and contrarian bets that the dollar will reverse course are starting to yield results.
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