The following article was written and posted on May 17th 2006. Since it was not posted on SeekingAlpha at the time and being that numerous belated articles blog about the topic now, here is a reprint.
Note that the ‘one more’ interest hike mentioned in the article was already in June.
Rising interest rates can be a double edge sword for the economy and equities. If the Fed increases to fast, the outcome can lead to accelerated inflation coupled with slower economic activity. This would be a double whammy for oil consumption and the economy.
The Fed tries to be one step ahead based on the economic data. I would give Bernanke credit that he foresaw the core inflation increase. This is the outcome of previously released economic data resulting in the last increase and Bernanke’s last comments alluring to the necessity of one more increase before pausing for evaluation. Yes, even the Fed has to pause in order to allow the markets to realign.
GDP growth can remain above 3% without necessitating another interest rate hike. The main inflation causing ingredient is not commodities but energy. The Bush administration likes to disguise this as a ‘tax on the economy’. I am not saying that the President is (or not) responsible for the high cost of energy. I am saying that energy is the underlying force for global inflation.
Proof of this can be found in the basic fact that there is no supply shortage of any commodity. Have you heard of a country or company outbidding another for delivery of copper? Is there anyone who could not get enough platinum for their production needs? Prices have increased on what I call ‘the fear factor’. For oil this fear is genuine as the spread between supply and demand is razor thin.
Demand for oil will remain strong for the foreseeable future. Raising rates will not bring down the cost of oil and in turn will not lower energy related inflation. A recession will. Alternative fuels will. Conservation and nuclear power would help.
Take your pick. Until then, there may be an investment opportunity in energy related stocks.
Is this going to be a prolonged downturn? Time will tell. What is for certain is that the market is going to be more volatile than usual during the next few weeks. Conventional wisdom has taught us that markets do not go up in a straight line.
The primary catalyst for the timing of the current correction is inflation woes. This at times gets translated into the ‘interest rate’ connection.
Until the markets see tangible evidence that the Fed has not lost control, one should expect some heavy swings in both directions.
Additional (current) Thoughts
The Fed can always raise rates twice more in the beginning of 2007 without causing a stock market crash and contain inflation as well. Also note that U.S. GDP growth for 2006 is pegged at 3+% and not the 4.5% that was accepted back in May.
Also note articles on SA about Exxon Mobil (NYSE:XOM) from 7/17/06 which is prior to the Q2 earnings report and a series of articles on Syneron (NASDAQ:ELOS) from 6/26/06 and 7/13/06, both prior to yesterday’s’ earnings report. Not to mention the 16+% stock move from yesterday alone.
Hindsight is the bloggers best friend. Foresight is what CrossProfit is all about.
Disclosure: This article was written by a member of the CrossProfit research team. This is a personal view and may not reflect the views of CrossProfit.com.