I have spent my entire investing career -- 36 years -- looking at what's called the micro: the bottoms-up analysis of individual companies. That's because I have always felt that if you wanted to profit from the stock market, you could best do so by doing your homework and finding stocks of the finest companies and buying those stocks at the cheapest prices possible.
For the most part, that's been a successful exercise. There are times, however, where doing the homework is of little avail or relevance. Right now is one of those times.
That's because many of the largest pools of actively managed money -- the hedge funds, the high-frequency traders and even the big mutual funds -- are not focused at this moment on individual stocks. Instead they are focused on how the Federal Reserve is keeping interest rates low, perhaps lower than they should be, in spite of data like that we got this morning showing an astoundingly strong 3.7% gross domestic product for the second quarter. That number, plus the very strong labor reports we have had, demonstrate that, in a vacuum, it is time that the Federal Reserve begin to raise rates after almost a decade of what amounts to free money.
But we are not in a vacuum.
The U.S. economy is quite strong; however, most of the rest of the world is quite weak and, with the exception of Europe, apparently getting weaker. That means that while it is easy to argue that we are experiencing robust growth (growth so powerful that short rates should be higher), the impact on the global economy could be very detrimental -- so detrimental that it could rebound and derail the growth we have had.
Obviously, when the Fed starts raising rates instead of keeping them low, there will be a massive change in psychology as stock buyers will then be fighting the Fed, which wants growth to slow to head off inflation. Given that we have to accept that the U.S. dollar will soar if the Fed raises rates, there could be a very specific earnings-per-share effect for U.S. companies, as well an acceleration of overseas turmoil given how emerging-market borrowing costs will increase as that dollar advances.
In other words, the impact could be huge, as we saw during a steep three-day decline that can very specifically be traced to comments made by St. Louis Fed President James Bullard that he's sanguine about the world's situation, including China, and the Fed is ready to move. Those comments made Friday afternoon, when the stock market was already going down, were like throwing gasoline on a fire in a crowded theater. When no other Fed authority contradicted Bullard, the selling accelerated and didn't relent when still one more Fed official, the Atlanta Fed's Dennis Lockhart, basically said that a rate increase sometime this year was in the cards.
This two-day rally, however, has its genesis with comments by the far more important New York Fed President Bill Dudley that were very different from those by the other two gentlemen. Dudley expressed a more pragmatic, nuanced view of what needed to be done, if anything, about rates. He was thoughtful, not dogmatic like Bullard and Lockhart, and that reassured the market and, most importantly, restored trust in the Fed. That and good news about China cutting rates and raising liquidity, plus a concomitant stabilization in commodities, including oil, turned things around.
Now, here's what you need to know.
After this drubbing that we are now recovering from, we are hearing more and more portfolio managers saying that they can deal with a rate hike. In fact, many are saying let's get it over with. I am sticking with my view that as long as the Fed is pragmatic, it will make the right move in either direction, stand pat or raise rates. And I am far more confident that the effect will be mild, as long as the central bankers have assessed the situation and acted the way they have said they would: with thoughtful regard for international as well as domestic inputs. This is the "In Fed We Trust" rally, not a "There will never be a rate hike" rally.
I, for one, am reassured that the downside is now fathomable regardless of the action taken. What a relief it is to know the grown-ups, not the ideologues, are really in charge. This huge sea change is conformation that I am not alone in my thinking.