In recent months we kept reading in media that the market crash or major correction is imminent. Many people believe and preach it. Many websites having polls installed indicate bearishness. Many advisers advocate cautious and moving money into cash.
Are you also concerned about the market crashing this year?
There are two factors which may affect the market this year – FED rising interest rates and what’s happening around the world, mainly in Europe. And Europe on the other hand may affect FED’s decisions in rising interest rates.
Let’s take a look at rising interest rates and why I think they will affect the stock market positively
There is one investment vehicle competing with stocks market – bonds. Bonds are a very interest rate sensitive instrument and people consider it as a safe investment while it no longer is. Bonds and interest rates are inversely related meaning that when interest rates go up, bond value goes down and vice versa, when interest rates go down, bonds are becoming more expensive.
If we agree on this relationship:
- interest rates up = bonds down
- interest rates down = bonds up
Then once FED starts rising interest rates all bonds sold while interest rates were low would start losing value rapidly forcing investors selling them with a loss or holding them until maturity for whatever return it is paying.
But rising rates will not save bonds. If FED raises interest rates in several steps and not only once in one big jump, all bonds issued in the meantime will become also less valuable. In other words, if now we enjoy zero interest rate and FED increases it to 0.25%, later to 0.50%, later to 1%, and later to 1.50% then all bonds sold during 0.25%, 0.50%, and 1% rate environment will be already at loss.
Would you buy an inevitably losing investment? You will be buying high and selling low. Unless you decide holding for example a 30 year bond for 30 next years until maturity.
In my opinion, whatever it matters, bonds will suffer a sell off when FED increases interest rates and moving money into the stock market. And the big investors know this. That’s why they may push the stock market lower at the beginning to scare retail investors from selling their bonds and moving them into the stock market. So, if stocks drop, buy. I bet it will be only a temporary dip.
Many retail investors have it backwards with bonds. In 2008 when we suffered big losses in the stock market, investors were selling their stocks at a loss and movi9ng their money to “safety” – bonds at the time when interest rates were dropping. Now they will be ripped off again when the rates start rising.
Negative rates in Europe will affect the stock market positively too
Imagine a situation that you go to your local bank and purchase a money market account, certificate of deposit, or just open a savings account, deposit $50,000 and the bank will charge you 0.50% interest rate annually instead of paying you.
And that’s exactly what’s happening in Europe today. Banks and institutional investors in Europe have trouble to place the enormous surplus of money in the market. In other words, they do not know what to do with it and where to invest.
Therefore they came up with a negative interest rate to discourage people and banks to save money among themselves. They no longer want your money. It is not certain whether this measure would work in a long term yet some banks started charging the negative rate. Among the banks which accepted this procedure are banks in Germany, Denmark, or Switzerland.
In November 2014 a German Commerzbank announced that they would start charging a negative interest rate to its most valuable and biggest clients such as insurance companies, industrial companies or mutual funds.
The reason behind negative interest rates is to force people to use the money and not to stash them in a bank. Central banks want local banks to use money for lending, investing, and people spending their cash.
Below see a chart indicating what’s happening in Europe:
Source: Reuters
If central bankers have problem with money surplus already, imagine what ECB’s decision to start QE and printing more money would do to this problem. Again, in my opinion, this will have a positive effect to the stock market in the US. If the negative interest rates will have the expected effect and force banks and institution to use the money, then they will go to the US market.
Why the US market? If they claim now that they have no other way to invest in Europe, the US market would be the second choice.
These are signs why I think we will not see the US stock market to fail this year and that we actually will see yet another bull run up similar to 2013 or 2014 one.
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