The Fed minutes were released today, and it triggered a sell-off in everything -- well, at least everything that Yahoo Finance tracks on its front page.
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The S&P 500, Dow 30, Nasdaq, 10-year bonds, gold, and oil were all down. How can everything be down? The markets are usually like squeezing a balloon, where if one area is squeezed/sold off, another area rallies as the cash flows into that area. Today, however, it looks as if everything was sold, and the money just evaporated. In reality, what happened today is likely what investors can expect occasionally going forward as the Fed approaches the "unwind."
What happened today is that investors most likely sold their risky assets and purchased cash. Traditionally, when interest rates increase as they did today other asset classes sell off, so today's reaction is typical given a historic perspective. However, I would argue, as I did in a recent article, that this isn't the likely scenario that will occur going forward as rates increase.
Historically, the behavior is as expected, but we aren't in historically normal times. I would expect that going forward an increase in interest rates will actually drive equities higher, not lower as they have typically done in the past. The reason for this is that the "reversion to the mean" is happening from below the mean of interest rates this time. An increase in interest rates will only represent a return to normal, not an actual increase on a relative historical basis.
Put another way, if we redefine an increase in interest rates as a deviation from the norm, we are in negative interest rate territory, so an increase in interest rates only gets us back to the starting point. Normally, increases in interest rates signal to the market that things are getting too hot and risk inflation. This time when interest rates increase, at least initially, they will signal that the economy is no longer in critical condition and can start be weaned off of life support. In my opinion, that should be good for the markets -- except for safe havens like gold and silver, and their paper partners SPDR Gold Trust (NYSEARCA:GLD) and iShares Silver Trust (NYSEARCA:SLV).
In conclusion, while most major asset classes sold off today because of the back-up in rates, I would not expect that to be the normal response going forward. Going forward, I would expect the equity markets and investments like SPDR S&P 500 Trust (NYSEARCA:SPY) to respond favorably to a slow and gradual increase in interest rates, and that the economy sits up and takes its first steps without the Fed's life support. This should be bullish for the markets, not bearish as it historically has been. Unlike past episodes, when increased interest rates were typically considered contractionary monetary policy designed to slow growth and contain inflation, this time we are starting the increase in interest rates with near double-digit unemployment, anemic global growth, and teetering on deflation. Those aren't the conditions that fit the historic norm on which the traditional market models are based.
The current rise in interest rates must be put into historic context, and when that is done the increase in interest rates today shouldn't be considered contractionary. At worst it should be considered a rating increase from critical and needing life support in the ICU, to being transferred to the general hospital for observation and recovery. The economy is still in the hospital and in need of care; it just no longer needs life support, and I would think investors will ultimately view that as a positive, not a negative, for equities. That, however, doesn't hold for gold and silver, which represented investor life preservers. Now that the patient has been removed from the critical care unit, there is no longer a need for the life support experiment -- and that bodes ill for GLD and SLV.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.