Markets have been trending higher, bouncing back from a one-day selloff as investors have been weighing potential market-moving political and economic events. The major headlines have included President Trump’s international trip, the Fed’s May policy meeting minutes and OPEC’s Vienna summit, where the organization voted for a nine-month extension of limitations in their oil production to keep a ceiling under oil prices.
The Federal Reserve released the minutes from its policy meeting earlier in May. The minutes confirmed that the Fed continues to expect to raise interest rates gradually over time, with eyes on June for the next hike. Markets study the Fed commentary closely to gain insight into what the Fed members thinking is going forward. After years of low rates, we’re in the beginning stages of rate increases over the next few years. They must be cautious in this process so as to not raise rates too fast which could choke economic growth, while at the same time heading off an increase in inflation from keeping rates too low for too long.
There is also the issue of how to shrink the $4.5 trillion balance sheet (which contains bonds and other assets) accumulated during their several rounds of quantitative easing since the financial crisis. Their policy was to buy U.S. government and mortgage bonds as a way to keep interest rates low. For now, the committee intends to begin, prior to the end of the year, gradually ending its practice of reinvesting proceeds from its maturing portfolio securities. Although the central bank stopped buying additional assets more than three years ago, the practice of reinvesting proceeds has kept the balance sheet at a steady level. This process could also have the effect of putting upward pressure on rates. Federal Reserve policy will be a major factor for the financial markets for the next few years as they we are clearly in a rising rate environment.
A rising rate environment need not be a negative. As long as corporate earnings and the economy are growing, markets will view gradually increasing rates as a positive. So far that has been the case. First quarter’s sharply higher earnings have driven the market higher and the Fed’s rate increases have been viewed as justified. Market’s will always obsess over a balance of higher rates versus the pace and level of corporate earnings growth. For now, rates and growth have been in sync and higher stock prices have reflected this.
The next catalyst will come in July when 2nd quarter earnings will begin their reporting period. In the meantime, there is always the possibility of what we call “headline risk,” some element of political or international event that could affect stock prices. Only time will tell.
D. Scott Peterson is CEO and head investment manager for Peterson Wealth Management may be reached at 775-673-1100/775-423-8007 or at Petersonwm.com.