Short-Term Pain Ahead

Rising rates and economic weakness is a recipe for market slumps. The likelihood, though, is that the pain will be short-lived, as it has been in the recent past.

Bonds and other interest sensitive investments will have a tough time the rest of the year, but the question is: when? Although we originally thought that the Federal Reserve would raise short-term rates in June, it will likely hold off because the economic recovery still appears shaky.

The first quarter results were just too weak for the Fed to raise rates at this time. The nation’s gross domestic product fell 0.7% and earnings for the Standard & Poor’s 500 companies were up a slightly less than 1%.

Odds are the Fed will wait until the September’s meeting at the earliest. The bond markets are already acting like interest rates are poised to rise, as they have risen quickly the past months. Since mid-April, the 10-year Treasury yield climbed to almost 2.4% from just under 1.9%.

What about the rest of the world? China will likely be even weaker than the slower growth they are projecting. It will probably be below 7% and this will spill over into 2016. While growth in the eurozone will be about 1.5% this year, the European Central Bank’s stimulus program – it is buying bonds to hold down interest rates, called quantitative easing or QE – is kicking in and will provide perhaps 1.8% growth next year. 

Because of the low valuations of their shares, however, the eurozone stock markets could produce some nice returns. Emerging markets like Russia and Brazil will continue to struggle, but others like India will likely do better. 

What’s the likely worst case for U.S. stocks? This summer, we could see the long-awaited 10% correction. The market hasn’t had such a downturn since 2011, and corrections historically occur every two years. Not to fear. In the long run, it will be healthy for stocks. 

This has been a skittish market for some time, one willing to dip at the slightest hint of bad news. Just before the Memorial Day weekend, we “celebrated” the second anniversary of Ben Bernanke’s famous pronouncement about the forthcoming end of the Fed’s QE effort.

The then-Fed chief’s pronouncement sent shock waves through both the bond and equity markets. Stocks stumbled badly and got close to a 10% correction and the bond market saw the 10-year Treasury’s yield increase by a full percentage point over the ensuing three and a half months. 

Of course, these short-term movements in both markets were just that – short term. Over the past two years, the equity markets have continued to increase, recently setting new all-time records while extending the six-year bull market.

Interest rates settled down and the 10-year Treasury even fell below 2% again.

So the odds are that, when the Fed finally does jack up rates the equity and bond markets will again slide. 

Should that happen, it will once again be a short-term event – even if the equity markets actually fall by 10% or more and yields spike. Looking ahead, we see continued growth, albeit slower growth than the Fed might like and thus, we will not panic. When investors react foolishly to short-term events, they generally end up only hurting themselves. 

Take a deep breath, as it could be a rocky summer. However, by New Year’s Eve, we expect the markets to be on their way to recovery as we head into 2016.

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V. Raymond Ferrara, CFP, CSA, is chairman and chief executive officer of ProVise Management Group LLC in Clearwater, Fla. 

This material represents an assessment of the market and economic environment at a specific point in time. Due to various factors, including changing market conditions, the contents may no longer be reflective of current opinions or positions. It is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Please remember that past performance may not be indicative of future results.

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