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Money Moves Markets

By Terry Savage on May 22, 2018

Interest rates are rising. The price of Brent crude oil edged over $80 a barrel for the first time in four years. The Russell 2000 broad stock market index managed to hit an all-time high last week. The U.S. dollar is strong. And commodity prices are generally higher, reflecting both demand and inflation fears.

Can stocks, energy, commodities and the dollar all manage to remain strong at the same time, while the 10-year Treasury note (on which mortgage rates are based) moves over 3.11 percent?

Obviously they can, and they are, for the moment. As long as the economy remains strong, unemployment remains low, corporate earnings continue to grow and trade remains vibrant, all those markets can celebrate together.

Sure, there’s a lot for the economy — and the markets — to worry about. Let’s take them in order.

Rising rates. There’s often a tradeoff as interest rates rise. Investors start to wonder whether it’s worth taking the risk of loss in the stock market when they can get a 3 percent yield on their money in Treasuries. And as rates edge higher, they will surely impact the stock market. But as long as short-term rates remain lower than long-term rates (the “yield curve”), investors and businesses can plan and invest. Only when the Fed is trying hard to curtail inflation by pushing short term rates above long-term rates (an “inverted yield curve”) does the stock market really get concerned.

Higher energy prices. For sure, consumers will see higher gasoline prices this summer, as they do every summer. And transportation costs will increase for goods trucked across America. But a lot of the recent rise in prices has been triggered by concerns over the Middle East. We’re in a far different situation than in previous oil crises. Now the United States is energy independent — and fully capable of drilling enough oil to supply our needs. Yes, global prices would rise on shortages caused by disruptions related to Iran but not enough to materially impact our economy.

Trade wars. It’s hard to calculate what’s going on in international trade, from our dealings with China to renegotiating NAFTA. The stock market is jumpy because there’s no official source of news, just seemingly off-the-cuff comments from the participants involved. Business needs a steady source of parts and raw materials. Not everything can be “made in America.” And trying to create that scenario would surely raise prices for everything.

Inflation. Rising prices are the hallmark of inflation. Inflation is defined as loss of purchasing power of the currency. Inflation doesn’t seem to be impacting the desire to own dollars these days, likely because the yields on dollar investment are higher by far than in other currencies, such as the Euro. And inflation isn’t as bad as generally perceived for the stock market. Just remember, the stock market (a broad cross section of large American companies, with dividends reinvested) has outperformed inflation in every 20-year period going back to 1926!

So far, the stock market has shrugged off most of these worries. It isn’t advancing at the pace of last year, but it certainly hasn’t collapsed. In fact, the market itself is likely its own greatest worry. We are now in the second longest bull market in history (the longest being the one that started in the 1990s, which culminated in the tech bubble), according to market historian Jim Stack. This bull market is twice as long as the average bull, going back to 1932. He points out that if the bull market manages to hit a new high in the fourth quarter this year, it will become the longest bull market in history.

Even more impressive according to Stack (www.Investech.com), about half of the bull markets in history have caused the major indexes to double in size. But he current bull market has more than tripled! It’s been an impressive run.

Bull markets don’t die of old age alone. Some sort of excess will eventually be the trigger for the end. Just remember the bigger they come, the harder they fall! And that’s The Savage Truth.



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