Here's What to Watch

The market quickly fell four percent from its high.  The financial media tell us many negatives -- geopolitical concerns, the threat of rising interest rates, etc. -- are adversely affecting the stock market.  Taken individually, the negatives are relatively insignificant.  As a group, however, they are enough to unsettle traders.  I said traders, not investors.

Geopolitical factors never have a lasting impact on the market so one should focus on earnings, which rose 11 percent in the second quarter, and interest rates.  Interest rates can be expected to rise if the economy shifts into high gear.  It is far from a certainty that growth will accelerate, however.  Since the recession ended in 2009 we've been told again and again that growth was about to accelerate only to be disappointed.  Remember the Obama/Biden "Summer of Recovery" bus tour?  That was in 2009!  Without the inventory buildup second-quarter GDP growth would have been less than 3 percent and final sales, a good measure of the economy, grew just 2.3 percent.  The economic environment can change quickly and so can expectations, as we recently saw.  To its credit the Fed continues to say that future policy moves will depend on future data.  Of course.

Goldman Sachs sees the first rate increase next fall with fed funds reaching 4 percent and the ten-year Treasury yield going to 4.5 percent in 2018 from 2.4 percent today.  Treasuries will return a mere 1 percent annually.

An unattractive bond market is good news for stocks.  In the fairly benign environment (GDP growth of 2 to 2.5 percent) Goldman foresees stocks will do well.  They forecast 2100 for the S&P 500 (an 8 percent increase from here) over the next 12-months on route to 2300 later.

Long-term investors, not traders, determine the market's direction over many years, and few are concerned about rates four years out and certainly not if they believe Goldman Sachs will be correct.  In the short term, traders can knock prices down by as much as five percent, and they do once or twice a year.  The reason, we are now told, is the incredible notion that investors are raising cash to take advantage of bond yields four years from now.  I think not.

Bottom line:  The main risk facing investors is not that interest rates will rise to a more normal level by 2018, as Goldman predicts.  No, the bigger risk is that the economy will disappoint once again and undermine profit growth.  I suspect not this time, but an awareness of that risk -- increasing to some -- plus normal profit-taking, really explains the modest selling in stocks.  

— David Vomund is a fee based investment advisor.  Information is found at www.ETFportfolios.net or by calling 775-832-8555.  Clients hold the positions mentioned in this article.  Past performance does not guarantee future results.  Consult your financial advisor before purchasing any security.