Stock Market Won’t Care if the Fed Doesn’t Raise Rates in 2016

The odds that the Federal Reserve will raise rates in 2016 are diminishing rapidly in the aftermath of the Brexit vote, but stock market returns are unlikely to be affected.

An interest rate hike later this year, even at the December meeting after the outcome of the U.S. presidential elections, appears highly unlikely.

"The near-term effect of U.S. monetary policy is unlikely to be a catalyst for volatility," said Edison Byzyka, chief investment officer of Hefty Wealth Partners in Auburn, Ind.

The stock market rebounded quickly after the massive dips following the Brexit decision, reversing its losses. The impact of Brexit and the labor market reports during the past two months has demonstrated that an interest rate increase, even during the next 12 months is becoming improbable.

"We're at a point now where it really doesn't matter what Fed Chair Janet Yellen says, because the market is convinced that higher interest rates in the U.S. are a myth, at least for now," Byzyka said. "Federal funds futures are also pointing to a similar conclusion."

The market is now immune to a lack of interest rate hikes, said Patrick Morris, CEO of New York-based HAGIN Investment Management.

"It's the worst kept secret in awhile," he said. "We called this several days ago."

A temporary sell off of a few points could occur after future Fed meetings when an increase is not announced, but the market should end the year in positive single digit territory, said Jon Ulin, a managing principal of Ulin & Co. Wealth Management in Boca Raton, Fla.

"The Fed may not want to stir up the markets during a presidential election year where we may soon experience significant turbulence," he said.

Investors are turning toward equities, because yields on government bonds, which are viewed as a safe haven investment, have continued to fall, said Bernard Weinstein, an adjunct business economics professor at Southern Methodist University's Cox School of Business in Dallas.

"Puny returns on government bonds make equities a more attractive vehicle for retirement plans," he said. "Americans with IRAs and 401(k)s weighted heavily toward equities should realize decent returns this year barring some unforeseen domestic or global economic shock."

Drawback of Low Rates

An extended period of low interest rates does not bode well for the global equity markets, Byzyka said. The current equity levels could be sustained artificially by current economic conditions while the true driver behind stocks is profits. The profits of many companies have demonstrated a "significantly weak trend over the past four quarters," he said.

"The aggregate equity market could largely benefit from a correction in the neighborhood of a decline of 20% before commencing to the next stage of a secular bull market," Byzyka said. "The continually revised analyst estimates provide a false sense of profitability strength for U.S. companies."

Delays by the Fed to raise interest rates will produce positive outcomes for the stock market only if the economy continues its upward trend, said Greg McBride, chief financial analyst for Bankrate, the North Palm Beach, Fla. based financial content company.

"The market is addicted to low rates," he said. "But if the Fed holds off because the economy slows or a recession threatens, that won't be good for the market or anybody else."

While the stocks of many companies still remain expensive and interest rates still remain near all-time lows, the market is now being dubbed, "TINA - There Is No Alternative," McBride said. "The Fed's hesitancy to raise rates only perpetuates this."

The lag in raising interest rates could be drawn out for as long as two years if the effect of Italy's bank default rate of 17% generates greater repercussions, said Morris.

"If Italy blows apart, the rally is over, but I feel like rate hikes are on hold in perpetuity until Brexit is fully enacted," he said. "If it reacts like there is a problem, rate hikes go bye bye until 2018."

Since the Fed will have to raise rates at some point, investors should view the current delay positively, said Matthew Tuttle, the portfolio manager of Tuttle Tactical Management U.S. Core ETF (TUTT)

"The market doesn't want the Fed to take away the punch bowl just yet," he said.

Markets still view uncertainty unfavorably and now the Fed's "hands are tied," said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. The stock market has tended to dislike environments when interest rates rise and the S&P 500, a benchmark index, rose 15.2% when rates dipped and grew only 5.9% when rates were increased from 1966 through 2014.

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