For investors, 2006 will start a little late this year -- about six months late, in fact. Sure, we'll flip open a new calendar on Jan. 1. But as common as it is to think that a new investing year starts with the New Year, it's especially important to resist that way of thinking as we head into 2006. Truth is, the big make-or-break events of 2006 -- the ones that will determine how different investing in 2006 is from investing in 2005 -- aren't scheduled to hit the calendar until later in the year. What will determine whether the New Year is a happy one or something much less cheerful depends on the way what I call my Five Big Ifs for 2006 play out.
If No. 1: Has the Fed Overdone It?
If the Federal Reserve has overdone it with the series of interest-rate increases that began in June 2004, economic growth will be slower than expected or desired. The rate hikes that began when short-term rates were just 1% are now widely expected to end in 2006 with either the Jan. 31 or March 28 meeting of the Federal Open Market Committee. Short-term rates, according to this scenario, will top out at 4.50% or 4.75%. The optimists among investors and economists believe that, at that level, rates will be just right -- high enough to fend off inflation but not high enough to stall the economy. One group of pessimists says the Federal Reserve is raising rates too high for an economy that has derived much of its juice in this recovery from a massive increase in consumer debt and a big bump in housing prices. Take away those stimuli by making it discouragingly expensive to borrow, and the economy will slow down faster than anyone now expects. Other pessimists say the Federal Reserve has moved too late and is too complacent. Inflation is back, they argue, and the Fed should pull its head out of the sand. We should know what the Fed has wrought by July at the earliest, or September at the latest, because it takes about six months for the effects of a Fed rate move to ripple through the economy. A slowdown in economic growth would be bad for the stock market, but it could produce a bond-market rally. A trend toward higher inflation would likely tank both markets.