The euro is now trading at a 12 year low relative to the U.S Dollar. The U.S. unemployment rate hit a 6 1/2 year low of 5.5% in February.
What do these two things have to do with the U.S. stock market dipping into negative territory for the year yesterday? If you read any headline, everything.
Here’s a quick explainer:
A strong U.S. dollar relative to other currencies it is bad two reason: it’s bad for U.S. exports because it’s expensive for other countries to buy goods from the U.S. If it’s more expensive for them, they buy less, then the U.S. makes and sells less which is bad for the U.S economy.
It’s also bad for U.S. corporations who operate overseas, and generate earnings in say, the euro. Why? Because when a U.S. corporation has to convert their euro earnings back to U.S. dollars earnings, they get fewer dollars now for their euros since the USD has rallied.
It gets worse.
Most believe the lower the unemployment rate, the higher the probability that the Fed will start to increase short-term interest rates sooner than expected. An increase in short-term interest rates tightens our ability to borrow (since we have to pay higher interest rates). Less borrowing means less spending, which supposedly means it’s bad for stocks.
Even if a stock market decline is a result of a sooner rather than later increase in short-term interest rates (which is 100% headline driven at this point), should we really be that afraid of the Fed increasing short-term interest rates?
No. Here are two reasons why.
1) Does this look normal? No. 2 – 2.5% is normal.
This is part of the reason why the interest rate you receive on cash at the bank is essentially zero. Would you like to earn more interest? I would. How about on any fixed income investments you own? Would you like higher interest payments from those? I would. That means short-term and long-term interest rates have to increase back to normal levels.
2. Look at the performance of stocks after fed increases rates.
“The average annual return for the S&P 500 during all 14 periods (when rates bottomed out to their peak) was 9.6%, including dividends” -WSJ
What? So why does everyone freak out about their stocks when they think the Fed is going to increase short-term interest rates?
These alleged Fed-driven pull-backs are no sweat on your back if you look at historical equity market returns during similar environments. Bonds? Be afraid.
The bottom line is we can’t have it both ways. Do you want “normal” inflation, interest rates, unemployment, and P/Es? Or do you want stocks to continue to rally up to space on the back of QE and corporate buybacks fueled by low interest rates?
Don’t answer that.
The latter is great until your stimulus beer goggles wear off, you’re in bed with Stifler’s mom, and not entirely sure what just happened.
Normal is good.