Positive Economic News But…
According to the Federal Reserve’s most recent Beige Book – a collection of anecdotal information on current economic conditions in each of its 12 districts – the U.S. economy continues to strengthen. Several districts reported a pickup in manufacturing, and the energy sector in particular was experiencing an uptick in employment for the first time in nearly two years. Numerous districts noted that it was getting harder to find qualified workers, an indicator that wages are likely to rise and that the pace of hiring is likely to increase. Across most industries firms were generally optimistic about growth in 2017.
Regarding interest rates, Chairwoman Janet Yellen announced at a recent Commonwealth Club meeting in San Francisco that it makes sense to move them up gradually, given an economy at nearly full employment and inflation approaching the Fed’s target of 2%. While she did not specify the timing and size of such increases, Yellin had previously suggested there could be as many as three rate hikes during the year. But she also cautioned that the ultimate pace of rate changes could be modified if the economic outlook changes during the next administration.
So what should investors do?
You could plow more money into U.S. stocks. After all, we haven’t seen such a rosy outlook since before the 2008 crash. On the other hand, there are two risks looming on the horizon. The biggest one is trade. While President Trump had been congratulating himself for twisting the arms of various corporate leaders to bring several thousand jobs back to the U.S., he has been simultaneously backing away from numerous international trade deals. If his actions are part of a negotiating strategy to ultimately knock down trade barriers worldwide, and he succeeds, corporate earnings are likely to rise, potentially boosting stock prices even further. If alternatively he is making his decisions based on a lack of understanding of economics and the role that international trade plays, we are likely to experience a prolonged slowdown that could have a deleterious effect on stocks (not to mention jobs).
The second risk to U.S. stock prices is a rise in interest rates. The low interest environment over the last number of years, a problem for retirees on fixed incomes, has been a boon for companies. The reduced cost of capital has boosted corporate profits to exceptionally high levels. A rate increase will directly impact many companies’ profitability, resulting in a potential drop in the price of their stocks.
So once again, what should investors do?
My answer, as always, is “nothing.” If your investment strategy is based on figuring out what the economy will be doing (good luck) or what the new administration will be doing (even more good luck), you are likely going to fail. On the other hand, if you are maintaining a well-diversified portfolio that is balancing your needed savings growth with the right amount of risk, you should have nothing to worry about. At least insofar as your investments are concerned.