The Trump effect on stocks is real. Markets have been on a tear since Trump’s election victory last year. The promise of lower taxes and fewer regulations has restored business and consumer confidence. The job market is improving too, giving more Americans money to use on the stock market.
The Trump effect has been matched by another important trend: Rising interest rates. This year the Federal Reserve has already raised interest rates twice. A third hike is likely before the end of 2017.
On a recent CNBC survey, 76% of respondents said they expected a rate increase in December. If it happens, it would likely be another increase of .25%. The Interbank Rate is currently at 1.16%.
Fed Chair Janet Yellen has also indicated she would like to start selling off the Fed’s $4.5 trillion balance sheet by the end of the year. If it happens, it would also push rates upward.
What does that mean for investors? Higher rates usually mean lower demand for stocks.
Higher interest rates mean less credit is available. That makes borrowing more expensive. Stock traders—the biggest brokers on Wall Street on down to individual investors—have to pay more to get credit. That tends to slow down the stock market.
There’s something called the “three steps and a stumble” rule. Raise rates (step) three times in a row, and stock markets will drop. Looking at history, the S&P 500 almost always takes a hit after a 3rd consecutive rate hike. That happened in 1955, 1965, 1968, 1973, 1980, and 1999. The only exception was 2004.
Will stock markets take a dive if the Fed raises rates again this year? Don’t bet on it.
Interest rates affect stocks. So do a lot of other factors. Oil prices. Inflation. Economic growth. Corporate profits.
All of the above factors are favorable, which is why the Trump effect on stocks has been so strong in the first place.
Take oil prices, for example. Prices have increased in the second half of 2017. They’ve also become more stable and are well below levels where they could start cutting into economic growth.
Next up, inflation. Consumer prices increased by 1.9% annually in August. That’s an increase over the previous three months. However, it’s still well below the historical average of 3.28%. No one, not even the Federal Reserve–which has a mandate to control inflation–is concerned that prices will spiral out of control.
Then there’s economic growth. Growth isn’t great. But it’s picking up. Official data from the Commerce Department said the U.S. economy grew by 3.1% annually from April-June. That’s the fastest growth in two years. The faster growth is due to higher consumer spending, increased investment, and stronger exports. Those are all good signs for the U.S. economy.
Corporate profits are strong, too. After-tax profits reached $1.774 trillion in the second quarter after topping $1.8 billion in Q1. That’s just slightly below record numbers from 2014. This might be the single strongest indicator of continued stock market growth.
Given all that, is an additional interest rate increase by the Fed likely to slow down the Trump effect on stocks? No, it isn’t. Expect the expansion to continue. The economy is strengthening and rates are still too low to seriously throw a wrench into things.
If the stock market does slow down, it won’t be due to interest rates.
If tax reform or President Trump’s $1 trillion infrastructure plan become realities, expect the stock market to really take off.