"A rate rise will be good for the market."
"It's the most widely anticipated rate hike."
"The Fed needs to act."
These are three examples of some of the recent comments we have been hearing leading up to yesterday's quarter point rate hike. It was nearly a universal view that a rise in rates would be positive. It was what the market needed were told--what the doctor ordered.
Today we are seeing the after effect of the rise: stocks are sinking. And they will continue to sink--maybe not day to day; maybe just slowly and gradually at first. But perhaps quickly. Why? Because rates will have a negative impact to the economy and to corporate profits.
Even before the rate hike we were seeing things like, falling durable goods orders, rising unemployment claims, weaker than expected manufacturing data, weaker money growth, and more recently, word from big companies like Wal-Mart and General Motors that sales are not meeting expectations.
Yet the market boosters were talking incessantly of an acceleration in economic growth, when there was none, and the positive impact of the Iraq handover, when, ironically, the impact could be negative if it results in lower defense spending.
They also speak of the improving budget deficit, even though it was high levels of deficit spending that lifted aggregate demand in this economy (and is still lifting it, but maybe not for much longer).
And as if all this were not enough, throw in the fact that China is stepping on the brakes, England, Australia and Switzerland (and now the U.S.) are raising rates; France, Germany and Canada are working to bring down deficits, and in the U.S., deficits have become the devil too. It's not stimulative--it's the reverse--it's contractionary. Acceleration? As my friends from Brooklyn would say, "Fuhgettaboutit."
Sadly, the market cheerleaders got some more bad news today in the form of earnings warnings from Cardinal Health and Emulex. Add those names to a list that includes Target, Wal-Mart, GM, Adobe Systems and Washington Mutual--companies that have either warned of weaker profits and/or weaker than anticipated sales.
As the market moves lower I can already hear the excuses: "The Fed didn't raise rates by enough." You can be sure they will say that. In other words, it is not enough to shoot yourself with a .45; next time use a Howitzer.
Personally, I think all the arguments for higher rates are preposterous. Yesterday my radio show guest was Warren Mosler, who summed it up by pointing out that the rate implied on the eurodollar futures contract five years out is 6-percent. That's the implied, 3-month rate. Well, 6-percent was the peak of the last rate cycle. However, back then capacity utilization was at 83 percent compared to current, 77 percent; productivity was growing at 2 percent compared to the current, 5.6 percent gains, and CPI was increasing at an annual clip of 3.5 percent, compared to 3.0 percent (based on last month's figure) now. Finally, the unemployment rate was 3.9 percent in 2000 and it is 5.6 percent now.
So, where is the big need to raise rates? Where is the overheating in the economy? It is NOWHERE! Has there been a price shock in energy? Yes, but guess what? The market is responding to that as it always does, by allocating by price, and more supplies are coming back on the market (witness the recent, and significant rebound in petroleum inventories).
No matter how I look at it, I cannot make a strong case for higher rates, nor can I explain investor insistence on this view. It is irrational in my opinion, and we all know what happens when investor behavior turns irrational.
Perhaps we can draw some analogies from Japan, where the stock speculative bubble peaked in 1989. Over the ensuing three years there was a collapse in the Nikkei, and economic growth started to contract. Then the Japanese economy stabilized and started to recover. So did the Nikkei. But in 1994 after regaining about half of its peak to trough decline, the Bank of Japan started raising interest rates again in response to the first signs of an economic upturn, and that was it. A new selloff ensued, carrying stocks--and the Japanese economy down yet again.
We may be going down the same path. The bubble-inspired drop in 2000 and then the shocks of 9/11 and the corporate scandals, sent the U.S. markets and economy down until correct fiscal and monetary policy reversed it all. Now that things are improving the Fed may be making the same mistake the Bank of Japan did when it raised interest rates. Better to have left well enough alone.
The secondary message of all this may be the following: Japan is the great place to invest right now. After keeping rates effectively at 0-percent for 10 years, the Bank of Japan sees no need to raise rates. Nor does the Japanese government see any need to restrict stimulus, despite some of the strongest economic growth recorded in over a decade. Bottom line: Own Japanese stocks.
Here are some names: EWJ, NMR, MTF, IX