Could Low Interest Rates and the Low Cost of Energy Propel the Markets Higher?
The current thesis that low energy prices creates a proxy and is indicative of poor GDP performance due to a lack of demand, manifested by the oversupply of energy, may initially create dislocation within certain industries. Namely, oil and gas companies, the companies and vendors that provide products and services to them and the banks that loaned money to them.
1% GDP Performance in the 4th quarter last year is not great.
The flip side of this argument is that if energy prices and interest rates stay low for any length of time, conditions could be ripe for markets to rise. Once the initial adjustment to lower energy prices resets the economy, low rates and low energy prices may provide the underpinning for economic growth, higher stock valuations and higher earnings per share.
In other words, low energy prices and low interest rates decrease costs and allow companies to competitively price their products and services, hire more people, increase wages and sell more increasing corporate sales and earnings resulting in higher stock valuations for those companies.
Core inflation (Ex Food and Energy) is at 2.2%. Above the Fed’s Benchmark Goal of 2%. While everyone worries about how the decline of oil and energy causes chaos for energy companies and deflates the economy, low energy costs lowered prices at the gas pump and at the supermarket. Low interest rates and low energy prices have historically been key drivers for the markets.
Combine this information with January’s rise in consumer spending and there may be a recipe here for a path forward for the markets.
Will this come to pass? Only if interest rates and energy prices stay low long enough to ignite the economy and we are willing to endure the pain of dislocation caused by the reset to propel the economy forward.
Certainly, other things can still happen to upset this apple cart. First, it’s an election year and depending how our elections shake out, the taxes that are levied and the budget that is created will have an effect. As will our deficit.
Second, further increases in interest rates by the Fed may cap growth.
While there seems to be a broad consensus for government spending more on health care and to help people fund their retirement, anything that helps consumers feel more secure so they spend more will be beneficial for the markets as consumer spending makes up 70% of the U.S. economy.
Geopolitical events are always a wild card and can disrupt any scenario. But, barring unforeseen shocks to the U.S. or global economy low energy costs and low interest rates are ultimately a good thing. Should rates rise which is anticipated to be the Fed’s desired route, the rise in rates will be a further vote of confidence in the economy by the Fed.
Remember, markets themselves are leading indicators of economic performance. The sudden correction, halt and reversal is telling us something. As is the volatility itself. Disruption to key areas of the economy such as energy and interest rates has this type of effect. It also creates opportunity.
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