Why I think the Fed holds the key for stocks

While the
key indexes marked time by essentially remaining range-bound for the week, it
was positive to see them hold up so well given the current backdrop. Both short
and long-term interest rates are rising, while housing inventories are rapidly
increasing. The yield curve, which has historically been one of the best gauges
of future economic activity, is inverted across most term structures. Certain
large-cap stocks, which have historically been seen as bellwethers for the U.S.
economy (e.g.
(
GE |
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(
INTC |
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(
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these factors would be very bearish. But, in spite of all of this, the equities
markets have remained relatively steady.

Much of the
reason for this resilient behavior continues to be based on the expectation that
the Fed will stop raising interest rates. Secondly, when compared to the last
10 years, the P/E ratio on the S&P 500 is still reasonable, meaning there isn’t
much overvaluation. Thanks to record profit margins, companies have been able
to enhance their bottom lines and post decent growth rates. An argument can be
made that these record profit margins are temporary, which would likely mean
that current earnings are near a peak for the cycle.

The key in
answering this question of whether or not earnings have peaked again falls back
to the Fed and whether or not it will stop raising rates before it causes a hard
landing for the economy. While it’s true that lower oil prices would also be a
positive, the equities markets pretty much have ignored oil and have moved a
long way under the cloud of higher prices. I continue to believe that interest
rates are the most critical component for the highest-leveraged economy in U.S.
history. With the next FOMC meeting more than 3 weeks away, I can’t see the
equities markets acting any differently that we’ve seen over the past
month. This would mean further range-bound action, as market players wait for
further guidance from the Fed on monetary policy. Because of this, it remains
important to not be flat-footed and to book smaller profits much more readily.