Stocks have been wavering in recent days as Janet Yellen’s speech at the Monetary Policy Symposium in Jackson Hole, Wyoming, looms ahead on Friday.
The Fed’s July meeting minutes and supporting comments are trending toward a rate increase sooner rather than later. The Fed will likely increase its federal funds rate 25 basis points in either September or December. While stocks have been wavering in recent days, investors should not be dismayed because the Fed’s rate increase is a good sign for the economy, and the U.S. equity market has even more room to gain.
The next rate increase
The economy has been growing at a steady pace with the exception of just one slow month (May) for the labor market and a volatile June following the U.K.’s Brexit vote. Both factors have stalled the Federal Reserve’s timing for a rate increase; however, the economy has managed to steam ahead.
Yellen’s speech (Friday at 10 a.m. EDT) will be a main focus for the market. Yellen’s speech is likely to set the stage for a rate increase in either September or December, echoing the positive market drivers outlined in a speech by Stanley Fischer on Aug. 21.
Yellen’s speech, titled "Designing Resilient Monetary Policy Frameworks for the Future," is also likely to provide the Fed’s expanded plans for repealing the accommodative easing policy it has been implementing over the last eight years. While the Fed’s easing of policy has had a high impact on the market and specific market sectors reliant on credit such as housing, the Fed’s repealing of its eased policy is likely to be less impactful with the economy’s growth over the near-term in greater spotlight.
The economy
The growing U.S. economy can be seen in the Fed’s key market indicators. The latest reading on GDP was as expected at the end of July with a seasonally adjusted annual rate of growth for the second quarter of 1.2% after an increase of 0.8% in the first quarter. The Fed’s inflation target is stable with the PCE Index at 0.9% annually. The PCE Index, excluding food and energy, is also approaching the Fed’s 2% objective at 1.6%. Labor market conditions have also been improving significantly with June payrolls up 287,000 and July payrolls following with another strong increase of 255,000. The unemployment rate is also at a healthy level below 5% at 4.9% in July.
For investors, the addition of corporate profit improvements has been another leading factor for confidence in the equity market. The most recent report from the Bureau of Economic Analysis (BEA) on June 28 shows corporate profit data improving significantly in the first quarter from the fourth quarter of 2015. According to the BEA, corporate profits overall increased $34.7 billion in the first quarter compared to a decrease of $159.6 billion in the fourth quarter.
Corporate profit data from the BEA also shows profit from U.S. financial corporations decreasing only $10.7 billion in the first quarter compared with a decrease of $24.0 billion in the fourth quarter. Meanwhile, corporate profits from U.S. nonfinancial corporations increased $75.3 billion in the first quarter compared to a decrease of $132.7 billion in the fourth quarter. The BEA’s first estimate of second quarter corporate profits on Aug. 26 is expected to show a continued positive trend in corporate profit improvements as well.
With the positive effects from the Federal Reserve’s eased policy baked into the current economy and continued improvements even more likely, investors have all the more reason for confidence in the equity market and its capability for continued gains. Overall, with the changing times and new monetary policy goals, investors will also be required to look less for clues from the Fed with a more normal investing focus on the underlying economy driving the market.
Support for further gains
While it is prudent to question all changing market factors when making investment decisions, a rate increase from the Federal Reserve should not scare investors from the equity market. As the economy continues to chug along, a 25 basis point increase will have minimal impact. A rate increase at the end of 2016 will only be a sign of the economy’s strength. With four months left in 2016, it should not cause investors to take money out of the equity market and in many cases should spur increased investment. With a year-to-date gain of approximately 6% for the Dow Jones Industrial Average and Standard & Poor's 500, momentum in equities is likely to only continue.
The positive economic trends and improving outlook on corporate profits for the third and fourth quarters only support further gains. Meanwhile, yields in the U.S. equity market through the remainder of the year provide even more incentive for equity market investment. With the global affects of Brexit primarily resulting in downward pressure on yields specifically following the Bank of England’s easing of rates, a 25 basis point increase from the Federal Reserve is likely to only have normalizing affects on the yield curve in the current environment – thus continuing to make U.S. equity yields attractive and safe.
Investing in equities
For investors, now is an opportune time to invest in equities. The Dow Jones Industrial Average is up 6% for the year with industrial stocks Caterpillar (CAT, Financial) and 3M (MMM, Financial) leading with gains of greater than 20%. The positive effects from the Federal Reserve’s easing policy are beginning to peak. Corporate profits should continue to evidence the benefits of a low-credit rate environment over the near term with gaining profit levels. Meanwhile, the current market effects from Brexit are also helping to fuel equity market growth in the U.S. as the domestic market provides greater opportunity for yield in a stable environment with improving GDP.
Given the current market factors, momentum in equities over the next four months should only continue and investors with money on the sidelines can likely benefit from any dips in the market as entry points. What Janet Yellen’s speech on Friday could provide is greater insight for investors over the long term as the market navigates a new environment focused more on positive economic growth and less on monetary policy easing. With the positive growth extending into 2017 investors may find the bull market has an even longer range for which to gain.
Disclosure: I do not own any stocks included in this article.
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