ECONOMIC AND STOCK MARKET COMMENTARY

The Federal Reserve continues to maintain a relatively transparent monetary policy. So, after months of expressing assorted concerns about the health of the economic up cycle, and holding interest rates unchanged as a result, a now more confident lead bank—which has been upfront recently in putting forth its evolving economic views—has opted to raise interest rates once again. News of this slight adjustment in rates, which had been widely expected, set into motion just a minor retreat when it was announced on December 14th. Looking ahead…

We think there will be less time between interest rate increases than there was in 2016, when a year had elapsed before the Fed decided to tighten again. Going forward, though, there seems to be emerging confidence on the economic front, aided by solid data on jobs, incomes, individual spending categories, and consumer sentiment. In all, with GDP growth likely to average consistently above 2% in 2017 and 2018 (buoyed by a rebound in energy-sector capital projects and possible adoptions of tax cuts and increases in infrastructure spending), the Fed could conceivably raise rates three times, or more, in each year. Meanwhile…

It may be a case of all’s well that ends well in 2016. To be sure, the third-quarter boost from rising exports and inventory investment is unlikely to recur in the current period, and that will exact a toll on growth. But with consumer spending, business fixed investment, and government outlays all projected to contribute in some measure, GDP could yet move up by 2%, or so, in the current quarter.

Still, there are some things that will bear watching. At home, there are questions about how many of the President-elect’s economic proposals will be adopted and how high interest rates (already at a two-year peak on the 10-year Treasury note) will climb. Globally, Europe’s growth outlook is less assured in the wake of Brexit; China’s business slowdown may well worsen; and the trend of oil prices is uncertain. All of that aside…

For now, the Santa Claus rally remains alive and well. To wit, the Dow seemed headed for the rarified air at 20,000, as we went to press, while the NASDAQ had inched closer to 5,500. Nevertheless, we warn that even powerful moves, such as this one, will encounter resistance at some point. Accordingly…

Conclusion: We counsel caution, as stocks are now quite extended.

Source: Valueline.com