James Paulsen, PhD is a well-known strategist for the Wells Fargo investment operation, Wells Capital. I think he’s very good, and a valuable resource. Over the past five+ years, he’s been consistently–and correctly-bullish about stocks. Of course, he, like me, has a bullish temperament.
What makes him particularly interesting at the moment, however, is that he’s saying something in his newsletter of November 14th (not yet available on the Wells website as I;m writing this) that’s distinctly not bullish. When a bull says something bullish, or a bear something bearish, it’s often a ho-hum event. But then their comments go against the grain, I’ve learned to pay attention.
Here’s what Paulsen is saying about US stocks in 2015:
If we study the past thirty years, when the Fed raises interest rates from recession-emergency lows back to normal after a recession, two opposing forces act on stocks.
–On the one hand, rising rates push down the price of bonds. This makes them more attractive as investments. As a result, investors shift some assets from stocks, pushing their prices down as well. Price earnings multiples contract.
–On the other, the Fed only begins to raise rates when it senses strengthening economic growth. Faster -growing earnings and more favorable than expected earnings comparisons make stocks go up, offsetting much or all of the downward pressure caused by rising rates.
However, these past instances deal primarily with garden-variety recessions, where the Fe is in a sense making mid-course corrections for a healthily-growing economy. The key point in these instances is that the interest rate rises occur early in the recovery cycle, when the economic rebound is unusually strong.
That’s not the case with this recession. The first rate rise will be happening about six years into recovery. Company inventories have long since shifted from a bearish posture to a bullish one (such as it is). Pent-up consumer demand, too, has presumably already played itself out. Therefore, we won’t have the “normal” earnings growth offset to rising rates. Stocks won’t go sideways to up during the rate rising period. They’ll go down.
Dr. Paulsen is certainly right that past experience will be a poor guide to the stock market’s reaction to rising rates. I’d been blithely assuming the contrary. But there are two other factors to consider. More tomorrow. (The power is just about to go off in our house. See you later!)