As the steward of the world’s largest economy, when U.S. Federal Reserve Chair Janet Yellen speaks on behalf of the Fed, people tend to listen regardless of where they—and their investments—are in the world. And earlier in May she had quite a bit to say. Speaking at a conference sponsored by the Institute for New Economic Thinking, Yellen described equity prices as “quite high.” She also suggested long-term interest rates could move sharply higher when the Fed finally raises short-term interest rates.
Sure enough, spooked investors shed stocks later that day, as reported by Bloomberg News on May 6, 2015. But what should we really make of what Yellen had to say?
Regarding equity prices, she’s right. They are high. In the absence of a decent yield on government bonds, investors have been driving up valuations for equities and other risky assets. It’s also true that the current economic recovery has endured about as long as recoveries typically last, therefore history might suggest U.S. equities are due for a downturn.
Our outlook on U.S. economic growth
Our own view, as noted in our recent 2015 Global Outlook – Q2 Update, is that the economy took such a nosedive in 2008-2009 that it still has some leeway before all the slack is taken up. How long? We expect at least two or three more years of positive growth. Not dramatic growth, but growth nonetheless. And in the absence of near-term recession risks, the downside to U.S. equities should be relatively limited.
While it’s perfectly appropriate for Yellen to discuss the state of the equity market, forecasting stocks isn’t really the Fed’s strong suit. Alan Greenspan, during his Fed chairmanship, made his famous “irrational exuberance” remark in 1996 and equities climbed for several more years.
Quick history of how markets react when the Fed speaks
The Fed on interest rates
Interest rates, on the other hand, are an area where the Fed obviously has tremendous influence. And Yellen isn’t alone in seeing the potential for long-term rates to move higher once the Fed starts its hiking cycle. Federal Open Market Committee (FOMC) members Stanley Fischer and William Dudley echoed similar comments in recent months. We think the 10-year Treasury is likely to move up to roughly 3% over the next twelve months, and that the U.S. economy is strong enough to weather it. After all, a 3% rate is still very low when you look back over the past few decades.
Russell Investments on possible rate moves
As for when the Fed will finally move, our analysis has suggested that September is the most likely date of lift-off, and we still believe that. March’s weak jobs report probably takes June off the table for a rate hike, but we don’t agree with those who now think it will be 2016 before Yellen moves. We continue to expect a reacceleration in economic growth later this year and for those stronger macro fundamentals to pull US interest rates higher.
The take-away
While the underlying growth trends for the U.S. economy remain healthy, we continue to see more attractive investment opportunities in other developed market equities like continental Europe and Japan (on a fully-hedged basis).
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