The Independent Market Observer

Some Thoughts on the Fed and Recent Tech Stock Performance

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Jun 13, 2017 11:38:24 AM

and tagged In the News

Leave a comment

thoughts on the FedThe Federal Open Market Committee (FOMC) kicks off its regular meeting today. Markets expect a rate hike to be announced on Wednesday. What I’m really interested in, though, is what the Fed plans to do about rates for the rest of the year, as well as how it intends to reduce its balance sheet.

Why we may see continued rate hikes

I do expect to see a rate hike tomorrow, not least because the markets expect it, but also because there seems to be a real shift in the Fed’s thinking, which has turned from worries about the risks of raising rates to worries about keeping them too low. Even the most dovish Fed members seem to have adjusted their positions recently. This says to me that the Fed is likely to keep raising rates. In fact, I would not be surprised to see language to this effect this week.

Higher rates make sense from several perspectives:

  1. With rates as low as they are, the Fed has little room to cut them if the economy weakens again. So raising rates now, in advance of the next recession, makes sense.
  2. Financial conditions are fairly easy right now, and the economy is doing better, so why not raise rates now? It could be harder to do so in the future.
  3. From a statistical point of view, the Fed’s goals have largely been met. Rates should reflect that, which means raising them.

All of this suggests to me that the Fed will indeed keep raising rates for the rest of the year. The real risk here is inflation, which is trending lower again. Unless inflation drops much more than it has, though, I think the arguments above still point to a need to raise rates. We will find out soon if the Fed agrees.

Why I’m not worried about tech stocks

The same factors that will keep the Fed raising rates—economic growth and easy financial conditions—are also likely to keep supporting the stock market, which is why I am not particularly concerned about the recent pullback in tech stocks. We have seen drops in some of the most highly valued companies, and the fear is that this is the prelude to another 1999. I do have concerns about that—and I will finally pick up the discussion again tomorrow—but I don’t think it is happening right now.

Why not? Tech stocks are, in aggregate, valued roughly in line with the market as a whole on both an operating earnings basis and a cyclically adjusted basis. In other words, based on what companies are earning, tech stocks are not substantially more expensive than other stocks. Moreover, if you look at what drove up even the marquee stocks (largely, growth), there still are not any other options out there.

We may see a further pullback—perhaps even a correction in some of the most highly valued stocks—but both the sector and the market are not any more at risk than they were before the pullback earlier this week.

Big picture, both the economy and markets remain well supported. The primary risks we face are medium term—say, in the next 12–24 months—rather than immediate. I expect to see the Fed ratify these thoughts this week and for the markets to respond appropriately.


Subscribe via Email

Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®