With all the recent pessimism about the US stocks and the predictions that the S&P 500 will either severely correct or even crash, one may start wondering (or even panicking) whether not to get out of stocks. People usually cite the end of QE and the possibility of rising interest rates as the trigger for a steep market correction/crash. Alternatively, bears remind us about some bad underlying performance of the US economy: job creation not fast enough, insufficient capital expenditure, disappointing consumer confidence, etc. And sometimes the monetary and the fundamental reasons for the professed market crash are used together as if they strengthen each other.

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However, both these arguments not only fail to convince but put together they sound illogical because they are mutually exclusive. The aim of QE and the low interest rates is to boost consumer and investor confidence by keeping rates at ultra low levels and making it easier for businesses and consumers to borrow. QE was implemented precisely because confidence and therefore fundamentals in the US economy were low after the 2008 Global Financial Crisis. To the extent that confidence remains low Fed monetary support will continue. If fundamentally the economy performs well and shows signs that it is gaining “escape velocity”, i.e. sufficient privately driven consumer and investor confidence that starts a positive self-sustaining cycle, then exceptional monetary policy will indeed end. But in that scenario the US economy will be growing healthily and companies will be boosted by increased volume of sales.

Now it is true that the current monetary policy made stocks relatively more attractive by keeping interest rates ultra low. This is because stock valuation is discounted by the interest rates: rates are a proxy for the risk-free rate and a means to calculate the equity risk premium that investors will require in order to stay in stocks. Low interest rates means lower discounting and higher valuations.

It is also true that rising interest rates will make equities relatively less attractive, all other things being equal. So bears are right that rate hikes can push shares down. But not all other things will be equal because rates are going to be raised only if the economy performs well enough to assume that it has reached escape velocity. When this occurs valuations of stocks will be pushed down based on steeper discount because of higher rates but at the same time profits will be rising given the recovering economy and the positive outlook that would have warranted the rate hikes in the first place. So in practice the switching of gears from low interest rates to slightly higher rates will only cause a short-lived correction that will soon be superseded by improved fundamentals. Or else if fundamentals fail to improve the Fed will lower interest rates again.

By way of example, yesterday the Bureau of Labour Statistics reported 209,000 new jobs created in July missing estimates of 230,000. This was not particularly good news but it immediately caused market analysts to observe that it may cause the Fed to continue loose monetary policy which is good for keeping the stock market high. That is when bad news is not really bad. In fact the news coming from the jobs market, even when looked at from a purely fundamental point of view, is not at all bad: it shows a stable positive trend of job creation at an average of above 200,000 jobs per month for the last half year. And then coming in is also the unequivocally good news on fundamentals on top of that –  US manufacturing index reached a three years’ high, standing currently at 57.1 beating estimates of 56.

Add to that the planned gradual increase of interest rates. Currently the Fed projects that in 2015 rates are expected to rise to 1.13% which is still a ridiculously low level. In 2016 rates are projected to reach 2.5%, not too high either. So that means that not only rate hikes will come as a result of strong underlying economic performance but the interest rate discount on stocks will be moved up gradually by small increments which will allow for a smooth adjustment of valuations to the reality of the economic fundamentals.

Despite all that the true bears would still remain unconvinced. The true bears are the QE haters. The people who believe that QE amounts to printing money and therefore would lead to very high inflation and who do not understand that QE only increases banks’ reserves at the Fed (see my post on that). These are the people who even think that hyper-inflation is already there only it shows in asset prices: somehow miraculously the “printed money” went into stocks without doing anything to the “real economy”. The true bears do not understand that the real effect of QE was in lowering interest rates and helping US banks and non-bank corporations clean their balance sheet and borrow cheaply on the bond market, locking in the low interest rates and preparing companies for increased capex when things improve. The true bears also do not understand that the real positive effects of QE is there to stay even after the rate hikes.

Investors should simply ignore them. True bears have been chanting the same song for five years. If one heeded their warnings one would have missed a great opportunity. If one listens to them now, further opportunities will be missed. True bears are the folk who will wait until 2016 to buys stocks. They will wait until it is absolutely clear that things are really going well. But by that time there might indeed be a market overhype and it might be “too late” to get in (whatever too late means).

In conclusion, let’s remind ourselves of the Wall Street lore: don’t fight the Fed! The Fed is intent on lifting the US economy and will stay on course until it is satisfied that the economy has gained escape velocity, there is just not other conceivable option. So putting geopolitical or other exogenous risks aside, the extraordinary monetary policy and US economic fundamentals are so correlated that it is a win-win situation for the US stock market: there will be either a strong recovery or prolonged loose monetary policy.

Disclaimer: the post should not be understood as advice to invest in US stocks. Markets are inherently risky and as the post notes there are numerous exogenous factors that may derail a recovery.