The Fed’s Patience Has Run OutSubmitted by AFS Wealth Management on April 27th, 2015
When I speak with clients, I always talk about making sound financial decisions. I urge them to not base their choices on faulty logic or misinformation. I want them to take the emotion out of their decisions. By taking emotion out of the financial decision-making process, they can take a hard look at the numbers, which often helps things become much more clear.
Regardless of the kind of information being evaluated, when we analyze numbers as part of that evaluation, it is critical to understand what affects them. What makes the numbers go up? What makes them go down? What makes them turn all around? You see, if you don’t know or understand what causes the numbers in an analysis to move, you can’t prepare for fluctuations in those numbers. And preparation, my friends, is crucial to any successful plan.
Since March 2009, there has been a 200 percent increase in the stock market. For many, that is all they hear and all they care about. However, I am interested in the reason for that rise, aren’t you?
One reason for that steady rise in the market is the Fed’s ongoing commitment to their near-zero interest rate policy. However, having not touched interest rates in years, the Fed is finally thinking it might be time to take off the stock market’s training wheels. Last week, the Federal Open Market Committee (FOMC) removed the word “patient” from its policy statement in reference to normalizing monetary policy. They have been “patient” for six years, and that patience seems to be wearing out. The expected date for the interest rate rise is June. This could lead to a bumpy ride on the stock market.
The market is always up and down, and that won’t change, but the turbulent nature of those ups and downs might get a little more extreme. In fact, the Dow has been on a downward run lately, with significant losses on more than one occasion this past week. Many are blaming that less than inspiring performance on the uncertainty around the Fed’s suggestion that interest rates will soon be increased. Unfortunately, things are likely to get even shakier as investors adjust to the effects of the Fed’s possible change in policy.
But it’s not just market investors who will be experiencing the effects of potentially rising interest rates. Mainstream America will feel them as well. Because interest rates have remained low as our economy has scraped and clawed back from the Great Recession, the Fed’s decision to soon raise this number is something of a high-five or an “atta boy” for our economy. One of the most obvious “benefits” of a rise in interest rates is increased earnings for people saving their money in the banks. However, that’s not a huge selling point since many Americans have abandoned the banks and moved their money to equities in order to get a higher return on their investments.
The decision to increase interest rates will also have an effect on corporate America. If you have been paying attention in my previous Phil's Phacts articles, you know that we have been in a bull market for six years, which is the fourth longest in our country’s history. A rise in interest rates will likely bring that train to a screeching halt. History shows that 80 percent of the time that the Fed has raised interest rates in the past, the markets have fallen in the following six months. This is why it is so important to be aware of and to understand the cause and effect of policy decisions. If the Fed is looking to raise interest rates in June, and 80 percent of the time this action has caused a drop in the markets, how are you going to prepare yourself for this?
A related concern over such an interest rate increase is the effect this will have on stagnant wage growth. Wages aren’t going anywhere fast, and many believe that bumping up interest rates will effectively tie an anchor to those wage rates by slowing corporate growth, as explained above.
It is expected, despite the long-term advantages of an increase in interest rates, that these short-term effects on corporate growth and wages could cause overall economic growth in the United States to stall or slow significantly. With global eyes on our economy, the interest rate hike will turn some heads. Putting the breaks on the American economy will likely cause other global economic powers to wobble as well.
Folks, there is no excuse for having your hand caught in the cookie jar if you have plenty of warning that someone is coming. So, what are you going to do to protect yourself and your money when the Fed changes it policy and increases interest rates?
Now is the time to look at your current strategy and understand how it will behave when this happens. Now is the time to look at your strategy and analyze how it performed in past market environments where volatility was significant. Now could be the time to seek solutions that will help to manage downside risk.
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