S&P 500: The Exact Opposite Of A Crash Is Happening

| About: SPDR S&P (SPY)

Summary

Yields are now rising across the board, but July was one of the best months in 2016.

Rate hike is back on the table, but the market is already doing some of the work.

The Fed is here to help investors by preventing a bubble, not creating one.

Inflation has been steady after the December hike, meaning the economy is not overheating.

Corporations are not so eager to take on more leverage despite lower interest rates.

Yields (TLT, IEF) are rising across maturities. Many investors believe higher yields would be detrimental to the stock market (SPY, QQQ, DIA) by making debt more expensive and increasing the required rate of return of all asset classes. The market isn't always right, but clearly this has not been the case.

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July isn't over yet, but we are currently looking at a return of 3% for the S&P 500. This contradicts the general sentiment that higher yields will be the bane of equities. Note that short-term yields have risen as well, so the argument that the Fed is propping up the market by holding off the rate hike is getting weaker. In a sense, the market is already doing the job for them by pushing yields higher. Yields are up, stocks are up. How do you explain that?

Despite this piece of "common sense," there is no evidence suggesting the Fed is somehow holding the market together by keeping rates low. In the past, the market has often panicked when the Fed threatened to hike. One adjustment later, the S&P 500 is now sitting at all-time highs. So based on experience alone, it would seem the rate hike in December actually helped the market. Of course, the Federal Funds rate is not a direct lever on the S&P 500 designed to inflate stock prices. In fact, it serves the exact opposite purpose: to suppress an overheating economy and to prevent a bubble. So I do find it quite fascinating that the market is averse to future rate hikes. Isn't a higher rate a signal that everything is going well?

Sometimes, things could be going too well. In an overheating economy, inflation often rises. In my previous article, I talked about how rapidly increasing inflation coupled with a tightening monetary policy may be the prelude to a crash. Corporations only saw the rosy short-term picture (higher inflation generally means more spending) and stretched their balance sheets. When the economy cooled, the leverage ate them alive. In those cases, higher rates exacerbated the problem, as they made refinancing more expensive. Of course, the Fed then lowered rates to correct the problem; though today, even that move is eschewed by investors, denouncing it as the cause of a "Fed-induced bubble."

Does the above sound familiar to you? Well, it shouldn't. There has been no rampant inflation after the Fed raised rates, and many companies today are most certainly not too keen on taking on more leverage (even though some should). Just ask Kinder Morgan's (NYSE:KMI) management team.

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Note how inflation's acceleration flattened after December. Readers can compare the above chart to the first graph in my previous article. The difference is night and day.

Takeaway

The market isn't going crazy. Since the economy is doing fine (read "Don't Be A Contrarian"), rising yields do not pose a threat. Investors should not be nervous about future rate hikes, as rate hikes signal that the economy is doing well - a positive for stocks rather than a negative. Of course, should your economic outlook differ from that of the Fed, then rising interest rates could be seen as the stepping stone that will lead to the next crash, as debt becomes more expensive with no corresponding increase in equity returns. Personally, I have not found any definitive evidence of a deteriorating economy, but I welcome readers to share their ideas.

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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.