2016: A Sea Change for the Markets
Almost 10 years of near zero interest rates has ended with yesterday’s FOMC announcement. Short term rates will rise to 1.375% next year from .375% right now. And, rates will go up 1% again in 2017 to 2.375%. The FOMC has left some wiggle room if the economy, jobs or inflation change significantly but, for sure, we are at the beginning of a rising tide of interest rates.
Rising interest rates, aside from negatively affecting bond prices, create real resistance for the stock market. At some point bond yields become competitive with risk adjusted stock returns, and earnings quality is reduced as sales increases may reflect price inflation as much as unit sales increases. As well, it costs more money for businesses to finance new initiatives, possibly slowing expansion.
Does this mean it’s time to exit the stock market, or does it mean it’s time to be more quality and price selective? Because the Fed has reiterated it’s intention to be very gradual and data driven in the process we believe it won’t be necessary to turn our backs on stocks, but it is time to double down on our homework.
Even within our favored industries for 2016, tech, biotech and financials, we feel we have to be more quality and price sensitive. Also, simply paying a dividend won’t be enough to make a stock attractive. Attractive companies will have much better than average cash flow dividend coverage as well as a business that can grow that dividend.
So, with higher interest rates pushing bond prices somewhat under water and stocks sailing against the current, 2016 will require some work to keep account balances moving up.