Signs of a recovery, albeit moderate, in the U.S. economy, are now evident, thanks to a solid labor market. Decent inflation, impressive Q4 earnings season, moderate retail sales, the passing of the tax reform and last but not the least uptick in global growth have been fueling optimism in the market.
Still, rising rate concerns occasionally dampen the Wall Street rally. Though tepid wage growth in February put off the blazing bets of faster Fed rate hikes this year, it is uncertain how long this speculation can be deferred. At the current level, the Fed is seemingly enacting three rate hikes this year, if not four.
Inside Hawkish Views
Goldman Sachs analysts estimate that there will be eight rate hikes in 2018 and 2019, economic growth will slow down to 2.2% in 2019 from 2.3% recorded in 2017 and bond yields may shoot up to as high as 4% (a mark not touched since May 2008). Notably, before Powell became the Fed head, the bank had penciled three rate hikes in 2018 and two more in 2019.
Coming to wage growth, it rose 0.1% to $26.75 in February, marking a slowdown from the 0.3% rise in January. However, some economists do not see this as a concern. Per Reuters, this group of economists believes that wage growth has actually been stronger than indicated by average hourly earnings, which appears more volatile on a monthly basis. Average hourly earnings for production and non-supervisory workers, which economists say are better measured, rose 0.3% in February, per Reuters.
Are Rising Rate Fears Overblown?
If we delve a little deeper, we’ll see there is no need to fear rising rate risks. The last full cycle of rate increases happened in the United States between June 2004 and June 2006 as rates progressively rose from 1.00% to 5.25%. The Federal Reserve started slashing rates from September 2007 through December 2008 until the rates reached the 0.00 - 0.25% range.
In December 2015, the Fed again embarked on a tightening spree and since then has enacted five hikes and brought key rates within the 1.25 - 1.50% range. Even if we assume four rate hikes this year, each worth 25 bps, key rates will not cross the 2.25 – 2.50% range. This is nothing considering the highs seen in 2005-2006.
Is U.S. Economy In a Mid Cycle of Recovery?
According to Fidelity, the mid business cycle of recovery is marked by factors like upbeat growth, strong credit growth, solid earnings growth and accommodative but neutral monetary policy. Many of these factors match with the current state of the U.S. economy. Plus, the tax reform is an added tailwind.
Moreover, if healthy stock market momentum is maintained, a wealth effect can be realized. As per Investopedia, “ the wealth effect helps to power economies during bull markets. Big gains in people's portfolios can make them feel more secure about their wealth and their spending."
As Fidelity sector strategist noted that “there is a high correlation between corporate profit growth of more than 5% and strong stock market returns,” we are likely to see wealth effect building up this year (given expected 2018 earnings growth rate of the S&P 500 is 20.7%).
Cyclical Sectors Sizzle When Rates Normalize
In a steadily-growing economy, most sectors surge from a wealth effect, with a few of the more cyclical corners making the most of this rally. These industries often sag in a slumping economy but are the biggest winners during a revival. Historically, cyclical sectors outperform the defensive ones when rates normalize.
4 Top Picks
The technology sector is on a tear lately. Emerging new technologies like cloud computing, big data and Internet of Things are expected to pull the sector forward in the coming days.
Unisys Corporation (UIS - Free Report)
A worldwide technology services and solutions company with a Zacks Rank #1 (Strong Buy) and a VGM Score of A. It belongs to a top-ranked Zacks Industry (top 42%).
The sector is likely to benefit from the rising income levels of consumers.
MCBC Holdings Inc. (MCFT - Free Report)
A manufacturer and marketer of MasterCraft brand premium performance sport boats. It has a Zacks Rank #1 and VGM Score of B. It hails from a top-ranked Zacks Industry (top 25%).You can see the complete list of today’s Zacks #1 Rank stocks here.
Per Fidelity, sectors like industrials do better in the mid-cycle phase of the economy. In any case, an industrial boom is apparent in the U.S. economy, thanks to Trump’s infrastructure plan and tax cuts.
Harsco Corporation (HSC - Free Report)
This Zacks Rank #1 company is a services and engineered products company. The stock has a VGM Score of A and belongs to a top-ranked Zacks Industry (top 10%).
Rising rate environment will lead to a favorable operating environment for financial stocks.
Heritage Insurance Holdings Inc. (HRTG - Free Report)
This is a property and casualty insurance holding company. It has a Zacks Rank #1 and a VGM Score of A. It hails from a top-ranked Zacks Industry (top 45%).
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