Financial markets gave the
Federal Reserve a standing ovation last week. At least, that was Barron’s interpretation. What did the
Fed do to deserve it?
“…the Fed did what
everyone expected, signaling that it could raise interest rates at any meeting
starting in June. Yet, Yellen and team still found a way to assure the market
that it wouldn’t do anything rash, insisting that the labor market would need
to strengthen further, and that inflation would have to be heading for its 2
percent target before they make a move. Even then, the projected path of
interest-rate hikes would be slow and steady – and unlikely to undermine the
market.”
Stock markets in the
United States weren’t the only ones heading toward, or surpassing, new highs. The
Fed’s reassurances about the pace at which it would normalize monetary policy
pushed markets across the Eurozone higher, too. Reuters reported global investors were feeling confident a weaker
euro could goose the region’s economy.
There is some optimism
about shorter-term market potential. Experts cited by Barron’s suggested the chance for a stock “melt-up,” which would
lift the Standard & Poor’s 500 Index (S&P 500) higher, were pretty
good.
However, others believe
the longer-term outlook for stocks, as a whole, may temper investors’
enthusiasm. Barron’s explained
earnings growth for the S&P 500 is well below its 30-year average, dividend
yields are well below their 20-year average, and the index’s valuation is “so
high that it is projected to subtract 2.6 percent annualized from returns. Put
it together and investors are likely to earn just 0.4 percent after inflation.”
One thing is for sure:
It’s awfully difficult to predict the future with any accuracy. Barron’s warned about the quirks of
market forecasts, offering an example from a decade ago. “In January 2005,
expected returns were just 0.4 percent, yet the S&P 500 gained 5.6 percent
annualized during the next 10 years.”
It may seem like a good idea today... If anyone needs more
evidence that focusing on short-term corporate performance can be detrimental
to longer-term outcomes, look no further than the effect of the strengthening
U.S. dollar on companies outside the United States that issued debt denominated
in U.S. dollars. The Economist
explained:
“Dollar borrowing is
everywhere, but the biggest growth has been in emerging markets. Between 2009
and 2014 the dollar-denominated debts of the developing world, in the form of
both bank loans and bonds, more than doubled, from around $2 trillion to some
$4.5 trillion, according to the Bank for International Settlements (BIS)… Recent
months have seen… an Indian property developer… a South African power
generator, and… a Turkish firm that makes TV dinners, sell dollar-denominated
bonds. By borrowing dollars at several percentage points below the prevailing
interest rate in their domestic currency, CEOs have pepped up profits in the
short term.”
As it turns out, dollar-denominated
debt may not work out so well in the long run. In recent weeks, the value of currency
in many countries has declined relative to the U.S. dollar which has been
strengthening. As a result, the amount of interest owed on bonds issued and
loans taken in U.S. dollars has increased significantly when measured in local
currency terms. Unless a company has U.S. dollar earnings to help offset the
expense, the higher cost of its debt can hurt the company.
The New York Times cited a leading electric utility in India that is
selling facilities and renegotiating debt after its debts increased thirty-fold
in just a few years. In Brazil, some sugar producers have declared bankruptcy,
in part, because of U.S. dollar debt and falling sugar prices.
The Times also pointed out, “…the rising dollar and falling
emerging-market currencies cut both ways for the economies in question. Even as
companies that gorged on dollar debt run into trouble, falling currency values
make exporters more competitive on global markets.” In January, the International
Monetary Fund projected economic growth in emerging countries will increase
from 4.3 percent in 2015 to 4.7 percent in 2016.
Weekly Focus – Think About It
“If you obey all the rules you miss all the fun.”
--Katharine Hepburn, Actress
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