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Higher Rates?

Weekly Commentary, 5/16/16 – 5/20/16

U.S. stocks rose Friday, reversing losses from earlier in the week.  For the week the S&P 500 Index rose 0.28%, the tech heavy NASDAQ Composite gained 1.10% and the Russell 2000 Index climbed 0.89%.  Oil jumped 3.3% to $47.75 lifting shares of oil and gas companies.   

The prospect of higher rates dampened the equity markets early in the week.  Tuesday stocks fell as investors fretted about the prospect of higher interest rates after a handful of upbeat economic data and comments from Federal Reserve officials increased investors’ expectations that rates could be rising sooner than expected. Sectors like consumer staples and utilities that tend to pay steady dividends were some of the worst performers of the day.  

Wednesday’s release of the minutes from the Federal Reserve Bank’s April meeting indicated the committee might raise interest rates as early as June if economic data showed the economy improving.  Some officials were concerned that market participants “may have not properly assessed the likelihood” of a June increase.  The Fed also toned down its view of global risks.  In speeches, several Fed officials expressed concern that the markets were under-estimating the chances of a rate increase next month. 

The strongest reaction was in the bond market as investors adjusted to the reality that the Federal Reserve is serious about raising interest rates this summer.  The yield on the benchmark 10-year Treasury Note, which moves inversely to bond prices, rose from 1.70% to 1.85% last week.   Benefiting from potentially higher rates were the financial sectors.  The S&P Bank Index climbed 3.37%.  Fed-Funds futures priced in the probability of a rate hike in June at 30%, up from just 4% a week earlier.  William Dudley, president of the New York Fed, said on Thursday he was “quite pleased that that probability has in fact moved up.”

The Fed would like to get out of the trap of free money.  However, a rate hike in June isn’t guaranteed.  The Fed may wait until its July meeting, in the event that Britain votes on June 23 to exit the European Union, an outcome that could cause global markets to come unglued.  In either case, the Fed is sending signals they plan on hiking rates.

Five months ago the Fed raised rates for the first time in almost a decade and the reaction was decidedly negative for global equites.  The S&P 500 Index fell almost 10% during the next month of trading as investors worried that higher rates would lead the way to a global recession.  Only timely Fed-speak calmed the markets.  Will the markets interpret higher rates as “good news” meaning the economy can stand on its own in a gradually rising interest rate environment or will it be interpreted as “bad news” leading to a stronger dollar, lower commodity prices and potentially negatively impacting global equity markets?

Technically the market is somewhat muddled.  Shorter term price and breadth measures have been weakening while the longer term measures are improving.  This dichotomy should correct itself over the next few weeks and provide a clearer technical picture of the markets.   

As we head toward potentially rising interest rates following a nine year experiment of zero percent interest rates and having accumulated a four trillion dollar Fed balance sheet, we are now in truly uncharted waters.  There are no text books to study or senior strategists to consult who have experienced a similar period in time.  Investment decisions will have to be made as data and events unfold while the markets grapple with conflicting signs. In periods of uncertainty, we believe it is more important than ever to have a disciplined investment process.  At Stadion our goal is to reduce portfolio volatility when warranted and avoid substantial drawdowns as market conditions evolve.  

The Stadion Managed Account Risk objectives are managed using a “core/satellite (Flex)” approach. The core positions will comprise 40-60% of the portfolio and are invested in equity, fixed income and money market instruments with the strategic allocation becoming more risk averse as the risk tolerance of each fund changes. In allocating the objective’s Flex assets (the remaining 40-60% of each portfolio) Stadion uses a proprietary, rules-based weight-of-the-evidence model. The Flex portion of the portfolios is in a transition zone. The portfolios are under the benchmark equity allocation at this time but above minimum equity allocation. 

 


Past performance is no guarantee of future results. Investments are subject to risk, and any of Stadion’s investment strategies may lose money. The investment strategies presented are not appropriate for every investor and financial advisors should review the terms and conditions and risks involved. Stadion’s actively managed portfolios may underperform during bull markets. Some information contained herein was prepared by or obtained from sources that Stadion believes to be reliable. There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change. The S&P 500 Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock price. The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market and it is highly followed in the U.S. as an indicator of the performance of stocks of technology companies and growth companies. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. It is the most widely quoted measure of the overall performance of the small-cap to mid-cap company shares. The U.S. 10-Year Treasury note is a debt obligation issued by the United States government that matures in 10 years. It is not possible to invest directly in indexes (like the S&P 500) which are unmanaged and do not incur fees and charges. The Sharpe ratio measures the excess return per unit of deviation, or risk. Any references to specific securities or market indexes are for informational purposes only. They are not intended as specific investment advice and should not be relied on for making investment decisions.

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Past Performance is no guarantee of future results. Investments are subject to risk, and any of Stadion's investment strategies may lose money.