As you see in the next chart, increased corporate debt loads place profits at risk.
It’s profits we need to worry about especially when valuations are high. This is a headwind to further market upside.
If you want to get a good sense for why high valuations lead to poor future returns, I wrote a piece this week for Forbes titled, Plump P/E Ratio Suggests Subdued Stock Market Returns Ahead.
The point is that debt is a drag on profits. It is concerning now but will be even more concerning when interest rates begin to rise. So it is forward we must set our gaze.
Chicago Fed President Charles Evans said last Tuesday that two rate steps this year are “not at all unreasonable,” while his colleague from Philadelphia, Patrick Harker, said he would like to see policy makers tightening borrowing costs “a little faster.”
St. Louis Fed President James Bullard said policy makers should consider raising interest rates at their next meeting amid a broadly unchanged economic outlook and prospects of inflation and unemployment exceeding targets.
Bullard added, “I didn’t want to be raising rates further in an environment where we had declining inflation expectations,” he said. Since mid-February, “they have bounced back up” so “that is making me feel better. We are moving in the right direction.” Source
Three steps and a stumble is an old rule on Wall Street. That means the Fed raises interest rates three times in a row. NASDAQ defines it as a rule predicting that stock and bond prices will fall following three increases in the discount rate by the Federal Reserve. This is a result of increased costs of borrowing for companies and the increased attractiveness of money market funds and CDs over stocks and bonds as a result of the higher interest rates. Frankly, I recall the rule to be two steps and a stumble but hey, birthday number 55 is knocking on my door.
Three steps seem to make more sense to me today as our starting place was from an unprecedented 0%. Rate hike number one is behind us. The Fed is fighting to create inflation (as are the other suspects: ECB, JCB and China’s Central Bank). All in, including the U.S., they make up over 70% of the world GDP.
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.