Rate Hike Comes Into View, What To Do?

The latest jobs report, released Friday, blew estimates out of the water. Coming in at 271,000 new jobs for the month of October—exceeding market consensus by nearly 100,000—the number, which came accompanied by a drop in unemployment rates, bolstered the case for a Fed rate hike in December.

Should investors react in any way by perhaps rethinking long-bond and equity exposure? Here’s what two ETF strategists had to say:

Steve Blumenthal, chairman & CEO, CMG Capital Management Group, Philadelphia:

There was nothing but good news in the numbers. Good news is bad. With the Fed more likely to raise rates next month, the market moved lower, the 10-year Treasury yield shot up to 2.32 percent—it was under 2 percent just a few weeks ago. And the dollar gained against the yen and the euro.

Fed members have been more vocal about a December rate increase. Markets were pricing in a 56 percent chance of a hike at the December meeting with the expected hike taking the Fed target to .375. After Friday’s jobs report, the probability of a hike goes up.

Let’s take a step back and jump out of the noise. Investing is relatively simple when valuations are low; it becomes much riskier when valuations are high. Today stocks are richly priced, and when they’ve been this expensive in the past, the annualized 10-year returns have been low. Period.

Current high valuations (median P/E ratio of 20.2 as of Oct. 31, 2015) are telling us that forward returns will be in the 3-4 percent range before inflation and advisor fees. The Fed’s been driving the QE bus for seven years. That ride appears to be ending. The markets inflated with QE. We can’t expect the same response when the juice is pulled away.

My 2 cents is to stay patient, positioned and prepared to buy when the data is in your favor. Until then, reduce and hedge that equity exposure, tactically trade fixed income and overweight liquid alternatives such as long/short, managed futures, tactical all asset, etc.

Michael McClary, chief investment officer, ValMark Advisers, Akron, Ohio:

The global economy has experienced a largely unprecedented level of central bank intervention over the last decade. There’s no question that actions by central banks have had profound impact on economic numbers and investment returns, especially since the financial crisis in 2008.

It’s still uncertain what the long-term effects of this intervention will be. Since equity results have been strong and economies are generally improving—albeit slowly—many would argue that the actions have generally had a positive effect on results in the short term.

Like any cause and effect relationship, there’s typically an initial result, then the longer-term effects follow over a period of years. For example, it’s typically positive to feed a hungry animal in the short term. However, if your assistance stops that animal from learning valuable life skills necessary for independence, the long-term results could be negative.

After several years of actions by the Fed that have propped up the U.S. economy and stock markets, we are now entering that awkward phase of reducing the support. If the support helped, it would be conceivable to believe that results would be somewhat lessened when that support is reduced. A concern plaguing investors is that the addiction to Federal Reserve steroids has been going on for so long that many can’t remember when markets existed without training wheels.

For example, after the latest jobs report, we saw several quick reactions:

1. The 10-year U.S. Treasury Yield jumped from 2.22 to 2.34 percent within two hours.
2. U.S. REITs, represented by ticker symbol SPDR Dow Jones REIT (RWR | A-86), dropped as much as 3.7 percent intraday Friday.
3. U.S. utilities, represented by the iShares U.S. Utilities (IDU | A-92), dropped as much as 4.3 percent intraday Friday [Nov. 6, 2015].

We feel that the textbook direct impact of a 0.25 percent rate rise in December is relatively low. However, we think this is not just a normal 25 bp rise. This increase carries an incredible amount of emotional baggage and uncertainty with it. As such, we would encourage investors to remain appropriately diversified in both their fixed-income and equity positions. This is a difficult time to take a big bet in any direction.

For the remainder of the year, we see interest rates, oil prices and the value of the U.S. dollar being primary drivers of stock and bond year-end prices.

Contact Cinthia Murphy at [email protected].