October 8, 2018

Stocks sank at the open today, following on Friday’s declines. The Dow is currently down 190 pts and the SPX is down .65%. Weirdly, utilities, real estate and consumer staples sectors are up sharply today while the rest of the market is down. I say that because the primary concern for most investors over the last week has been rapidly rising interest rates. And it is axiomatic that the sectors listed above don’t typically fare well when rates are rising. European markets will close down about 1% as the Italian banking sector looks weaker. Asian markets were also down overnight. The VIX Index—a gauge of fear among traders—jumped to 17.4 today, the highest in a little over a month. The dollar is stronger against a basket of foreign currencies and commodities are mixed. WTI crude oil is down around $74/barrel. Gold and copper are also lower on the day.

The bond market is closed today for the holiday. But now that the 10-year Treasury note yield has climbed to 3.23%, investors are beginning to wonder if rates will stabilize at this level for a while, or continue rising. Art Cashin, director of stock exchange floor operations for UBS, says he’s concerned that the 10-year may climb to 3.75% before too long. He’s thinks the Fed Reserve may go too far with interest rate hikes. That is, the Fed’s goal to “normalize” rates may end up spooking the stock market.

Wharton Professor Jeremy Siegel was interviewed on CNBC today. He believes rising rates & inflation will likely cause a slight pull-back in the stock market, or at least a plateau for some time. The Fed is set to raise short-term rates in December and then another three times next year. One big reason for that is that the job market is extremely tight. And in the past, when the unemployment rate fell to 3.7%, wage inflation was “unleashed.” If the 10-year moves up along with that, it’s going to be a headwind for stocks.

Of course, Bloomberg points out that “yet absent from this equation is any indication of inflation becoming unmoored.” Indeed, it may well be that the recent spike in the 10-year Treasury yield is more due to continued signs of a strong economy than to signs of rapidly rising inflation. In fact, Fed Chair Powell’s stated reason for supporting continued interest rate hikes is the strength of the economy. And the three main gauges of consumer price inflation—PCE, CPI, UIG—all corroborate roughly 2% inflation. In this view, the Fed is raising interest rates not because of inflation, but because they want to build up a rate cushion for the next recession.

Jim Paulsen of Leuthold Group points out that two key inflation reports (PPI and CPI) are due this week and traders will be fixated on them. His primary concern isn’t rising inflation, but rather slowing growth. What if economic momentum slows down? If we “remove those fantastic fundamentals”, but “leave a higher rate structure in place,” the stock market would get hit. He doesn’t foresee an economic recession or a sustained bear market, but he does encourage investors to overweight defensive sectors and overseas (developed) markets. He also likes commodities. Mr. Paulsen predicts a correction over the next several months and will likely view it as a buying opportunity.

CNBC Contributor Josh Brown’s take on rising rates is more constructive: He reminds us that stocks have been performing very well as bond yields nearly doubled over the last two years. So rising rates is not a new trend. “You can have rates rise, and you can have excellent follow-through in stocks because fundamentals are improving, and then you have to deal with these periods of ‘uh oh is it too fast?’” He also points out the rates should be rising. At 4% GDP, we don’t need interest rates to be at “emergency levels.”

Blackrock’s Rick Rieder says rates won’t be moving much higher than current levels. The Fed will probably only raise rates twice next year because economic growth is backing down off the 3-4% GDP growth level. Global growth is “turning down significantly.” Therefore, he’s not “worried about interest rates killing off growth.”


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