A Fed-led Santa Claus rally this year? Ba humbug!

After Fed Chair Janet Yellen delivered just the right mixology of rate increase to show confidence in the economy and restraint on future hikes so as not to drain too much liquidity from the monetary eggnog bowl, some Grinch stole the presents that had magically appeared, namely a mid-week 30-point gain in the S&P 500, 220 points in the Dow Industrial Average and 76 points in the Nasdaq.

Some might argue that investors had their Santa rally in early November when the S&P hit 2109. Regardless, this week's pull backs in the major averages are lumps of coal, a disappointment that, perhaps, stocks won't rise much further this year.

The market, of course, often sends back some of its gains after a major announcement. And after these short-term tears dry, expect a mildly positive year for stocks, in general, in 2016.

With the economy moving ahead, the Fed, as was largely expected, nudged up short-term interest rates, by 25 basis points, and the dovish language in Yellen's statement regarding future interest rate increases was a Merry Christmas card for stock market bulls, too.

Yellen noted that the Fed's interest rate policy "remains accommodative" to growth and will require "only gradual increases" over next few years.

She also said the Fed "will carefully monitor actual and expected progress toward its inflation goal."

One almost has to be a linguist to translate Fed-speak sometimes, but it is fairly clear those words represent both an ongoing data dependence on inflation figures, which have been running well below the Fed's 2% target, and the expectation that energy prices are nearing a bottom. Yellen again highlighted her committee's view on the transitory nature of commodity price weakness and that they were reasonably confident inflation would move toward its target.

The Fed believes the federal funds rate, which affects short-term rates, will reach 1.4% by late 2016, rise to 2.4% in late 2017 and hit 3.3% by the end of 2018.

Personally, I believe the Fed, in an effort to achieve its goal of 2% inflation and maximum employment, probably won't raise the federal funds rate more than three times to 1% by year-end 2016, and the yield on the 10-year Treasury should remain under 3%.

As long as corporate earnings don't tank, and I don't believe they will, we should have calm sailing weather for the stock market. Today's fairly valued market means stocks will likely produce only mid-single-digit returns next year. But investors should not fear the market in the face of the Fed's rate hike. It's a vote of confidence in the economy.

The foreseeable headwinds come from the deflationary collapse in energy prices, which should abate later in 2016, and the resulting reduction in capital expenditures. The strong dollar, which boosts prices of exports, may have a lesser impact.

Clearly, Yellen believes there is little danger the modest growth in the economy will reverse course. I concur and, in fact, think growth could pick up a bit.

Maybe Santa's sled is running just a little behind schedule this year.

 

This article is commentary by an independent contributor. Debra Silversmith is Chief Investment Officer for First Western Trust in Denver. At the time of publication, the author held no positions in the stocks mentioned.