10 Reasons For The Fed Being 1 And Done Through 2016

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Includes: DIA, IWM, QQQ, SPY
by: David White

Summary

The Fed forecast a +1.25% rise in the Fed Funds rate for 2015 as late as September 2014. The actual rise was +0.25%.

The Fed has forecast an end of 2016 Fed Funds rate of 1.375%. This seems as unlikely to come to fruition as the September 2014 Fed forecast for FY2015.

The Chinese economy is unlikely to be the savior for reasons detailed in this article.

The US equity markets are already over inflated; and they are likely to get more so with the current earnings recession expected to continue in Q4 2015.

Hopefully this article will improve your investing results.

Against many people's advice the Fed raised its Fed Funds rate in December 2015 by +0.25% to a range of 0.25%-0.50%. This list includes Larry Summers (a former US Secretary of the Treasury), Mark Faber (of the Gloom, Boom, & Doom Report), Christine Lagarde (head of the IMF), myself, etc. The current forecast for the Fed Funds rate at year end 2016 is 1.375%. However, investors should remember that 1.375% was the Fed's median forecast for the Fed Funds rate for the end of 2015 as late as September 2014. This would have been a raise of +1.25% in FY2015. Reality turned out to be a raise of only +0.25% for FY2015; and that was an ill advised raise.

The following are a number of reasons that the Fed may be done raising Fed Funds rates for at least another year:

  1. 2016 is an election year. Politicians usually put pressure on the Executive Branch (the Fed is part of that branch) to do everything it can to ensure that the economy is growing well during the election year.
  2. The Fed has been citing an unemployment rate of about 5%; and it expects this rate to move lower into the 4%-5% range in 2016. However, this rate is highly misleading compared to employment levels in 2008. In other words, the rate is only low because millions have dropped out of the "official workforce" -- those that are actively looking for work. If you were to add those millions of drop outs since 2008 back into the unemployment level calculation, the unemployment level would be over 10% for all of 2016. I am not talking about the U6 figure, which includes the partially employed who would like to be fully employed. If you add the partially employed people into the total of unemployed, the US unemployment figure would be north of 15%. To say the US is anywhere near full employment relative to employment levels of 2008 is a gross mischaracterization of the facts. Fed Chair Janet Yellen even seemed to acknowledge this as she de-emphasized the unemployment rate in her December 2015 Fed Funds rate raise and outlook announcement. Instead she emphasized the inflation rate.
  3. The third estimate of the Q3 2015 GDP Growth was for growth of +2.0%. This was down substantially from the final Q2 2015 GDP Growth estimate of +3.9%. It indicates significant slowing going into the Christmas season. Plus remember that the Federal government made adjustements to the way the number was calculated in Q2 2015 so that it would be higher than it would have otherwise been. At least some feel that these "adjustments" are dishonest; and they are hiding the truth about the US economy. Even with the adjustments in place, the US economy slowed dramatically in Q3 2015 from Q2 2015.
  4. The US had what some have called an "earnings recession" in Q3 2015 with negative earnings growth in the S&P500 in both Q2 2015 (-0.4% year over year) and in Q3 2015 (-1.3% year over year). These were the first back to back quarters of blended earnings declines since 2009. The blended revenue decline for Q3 2015 was even worse at -3.9% year over year. All of the above Q3 2015 figures were after 98% of the S&P500 companies had reported. The chart below (from FactSet) shows what the above has done to the S&P500 price line versus the forward 12 month EPS line. It sure looks like the EPS line is going to drag the price line downward.

  1. When you consider that as of December 24, 2015 the S&P500 earnings decline is expected to be -4.9% for Q4 2015, the forward 12 month EPS line is likely to drag the price line down even further. Admittedly the estimates usually start to go up once the earnings season begins; but even if earnings results (beats) lessen the decline by +3%, that will still leave the S&P500 with a decline of -1.9% in earnings for Q4 2015. That's still a negative. It would be the third straight quarter of earnings declines for the S&P500.
  2. The Materials sector has recorded the largest drop in earnings estimates since the beginning of Q4 2015 (-6.1% to -25.0%). This is still a big problem area for the economy. It is expected to continue to be a problem throughout 2016. Remember that many oil and gas companies will see their hedges disappear as 2016 progresses. That will lead to decreased profits. Remember too that many expect there to be severe problems with oil and gas development company credit as 2016 progresses. Higher rates will also lead to decreased profits. The Fed Funds rate hike will not help in this regard. This will lead to further new development cutbacks. More oil and gas workers will be put out of work. That will in turn negatively impact US economic growth in 2016. A slowing US economy will tend to exacerbate the decline in oil and gas prices. A stronger USD will tend to exacerbate the decline in oil and gas prices.
  3. In October 2015 the IMF cut its World Economic Outlook for FY2015 to 3.1% from 3.3% in July 2015. This was not the first cut in 2015. A slower world economy can be expected to have a negative effect on the US economy.
  4. For the last two years the US has been growing its trade deficit by approximately $30B per year. The stronger USD partially due to the raise in the Fed Funds rate is likely to add to this trend. A higher trade deficit will lead to further losses of US jobs. This will hurt US economic growth and US revenues and earnings.
  5. The Fed's favorite inflation index is the BEA's Personal Consumption Expenditures Chain-type Price Index. For November 2015 this was +1.33%. This is significantly below the Fed's stated +2% price growth target. The PCE Price Index chart below shows a down trend in this index will little or no sign of an uptrend starting. Further if oil prices flounder as currently expected by many in 2016, that would put added pressure on inflation to move downward, even "core inflation".

  1. Some think that growth in China and the other emerging market countries will pick up. However, both Russia and Brazil have economies that are heavily dependent on oil. Both of them seem sure to flounder in 2016. Another major point that many do not see is that Chinese growth has to slow. In 1990 China's share of the world economy was about 1.47%. China's share of the world economy was 12.3% in 2014. Approximately 7% growth in 2015 would put China's share of the world economy at about 13%. Specifically 10% of the 1.47% share in 1990 was about a 0.147% grab of the world economy, while 7% of 12.3% is about a .861% grab of the world economy. To be truly accurate, you would have to subtract out the overall world economic growth to approximate the "grab" by China. As China continues to grow it inevitably has to slow down to more closely approximate the rate of growth of the world economy in general. This is now forecast by the IMF to be 3.1% for FY2015. The above numbers still paint the correct picture though. China inevitably has to slow, or it will become the entire world economy. Since it is very dependent on exports, that would be a disaster. No other country would have any money to buy its products with. The same is true for the emerging markets economies in general. As China inevitably slows, its credit problems are sure to rear their heads. Many of its current outstanding loans were made with the expectation of 10%+ GDP growth per year. It is becoming clear that that was an unreasonable expectation. China will inevitably crash in order to deal with its bad loan situation. These may be as high as $6T-$8T; and they are growing with each year that China avoids a recession. The result may be almost cataclysmic. The take away lesson should be that China is unlikely to be the savior of the world economy. It is too troubled. The three articles linked to below about China provide some extra color to this picture (link1, link2, link3). One of the preceding links is about smog; and that has already worsened. Beijing had to substantially close down in December 2015 due to a "red alert" smog status -- the highest dangerous air quality alert level. That was not good for the Chinese economy; and the situation seems only likely to get worse within the next few years.

I could go on. There are any number of weak US economic metrics at this time. However, I believe I have made my point for the near term. The S&P500 companies are already telling us Q4 2015 will be a weak quarter; and Q1 is historically often a weak quarter. Things could get substantially worse in early 2016. Beyond that we will have to see. A lot may depend upon how well the oil companies in the US survive. Since many think the US oil and gas development companies credit crunch will come in the summer of 2016, the US economy seems unlikely to get better until that is past. In fact it may get substantially worse first. Investors should be prepared for that to happen. That does not mean they should be assured that the worst will happen; but they should probably decrease their amount of risk. In your personal forecast you should consider that the Fed may be "one and done" (the one already done) with respect to raises through 2016. This article is especially relevant to the SPDR S&P 500 ETF (NYSEARCA:SPY), SPDR Dow Jones Industrial Average ETF (NYSEARCA:DIA), PowerShares QQQ ETF (NASDAQ:QQQ), and the iShares Russell 2000 (NYSEARCA:IWM). These reflect the overall economy well.

NOTE: Some of the above fundamental fiscal information is from Yahoo Finance.

Good Luck Trading/Investing.

Disclosure: I/we 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.