Is another interest rate hike coming?

In 2008 and 2009, the market was in the midst of a massive stock market meltdown and was on the verge of an economic collapse. Since that time, banks have recapitalized, market values have recovered, and consumer confidence is at a 9 year high. The recovery has largely been driven by strong corporate cash flows and stock buybacks. We have just experience an incredible innovative cycle of technology advances such as cloud computing, genetic engineering, artificial intelligence, the creation of an app economy, and the proliferation of smartphone’s.

There has been an ongoing debate about other reasons why economies around the world have rebounded so strongly.  How much of the economic expansion has to do with the creation of leverage and debt? Central banks around the world have issued a massive amount of debt into the system and companies have also raised money through debt offerings. Bloomberg reported the other day that the world debt level is at an all-time high of $152 Trillion.

Over the past two weeks, markets have begun to realize that central banks are going to be much less accommodating. There is a strong probability that the Fed will raise rates once again at the end of the year.  In my September 2016 outlook, I warned that Utilities, REITs, and Telecom stocks were acting as bond proxies because they pay above average dividends. Investors were starving for dividends which created a “yield bubble”. The air has gotten released from the bubble as the Utilities (symbol XLU) and REIT (symbol VNQ) sectors both have seen values drop more than 10% from their respective highs.

Up until now, the higher market valuations have moved in tandem with the issuance of new debt. Economic growth has been low, but there have been signs of inflation. Medical care costs are out of control and home prices have re-inflated. Also, commodity prices are back on the rise and skilled workers are becoming harder to find. In July, job openings hit a record high. The Fed has good reason to raise rates again. I don’t believe that the Fed will be able to raise interest rates without negatively impacting asset prices.

As the Fed increases rates, I’m less optimistic that investors will be able to harvest the same type of returns that they have experienced over the past 5 years. Without the extra liquidity, earnings growth may slow and markets are starting from higher valuations. If the pattern holds, the Fed raised rates at the end of 2015, and they will raise rates at the end of this year. Next year should play out as it did in 2016. There will much discussion about a third interest rate increase, but the Fed will wait once again until they are certain that another rate hike will not hurt job creation. This belief has many implications and may open up new investment opportunities in the coming months.

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Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

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