Likelihood Of 2016 Rate Hike Rapidly Decreasing

Employee compensation is spiking higher and not because labor is tight, or due to a demand for higher wages (outside of the mandated minimum wage increases in several states) but directly due to the impact of the “Un”-Affordable Care Act. Importantly, rising employment cost impacts have been a precursor to the onset of recessions historically.

As stated in this past weekend’s missive, the risks of a recession have risen markedly in recent months and may arrive in mid-2017. Of course, before we get to that point, the ongoing economic deterioration due to the impact of the stronger dollar and higher interest rates will have already beat the Fed to the “removal of the punch bowl.”

This leaves the Federal Reserve with a very difficult challenge ahead of them and very few options. While increasing interest rates may not “initially” impact asset prices or the economy, it is a far different story to suggest that they won’t. In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest-rate hiking campaign that has not eventually led to a negative outcome.

The Fed surely understands that economic cycles do not last forever, and after eight years of a “pull forward expansion,” it is highly likely we are closer to the next recession than not. While raising rates in December will accelerate a potential recession, and a significant market correction, from the Fed’s perspective it might be the “lesser of two evils.” Being caught at the “zero bound” at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline.

For Janet Yellen, the “window” to lift interest rates appears to have closed which is a policy nightmare for the Fed, the economy and you.

While Bill Gross thinks the Fed will hike rates next year, I suspect we will more likely be talking about rate cuts instead.

Over the last several months, as market turmoil has increased, the litany of articles on “passive vs. active” investing have multiplied. My position remains that such musings are symbiotic with late stage bull market advances and the eventual market correction will rapidly remind individuals of the consequences of overly simplistic strategies in extremely complex environments.

As I have often stated, the biggest problem with passive indexing strategies is not the destruction of principal from market downturns, but the loss of “time” getting back to even. While capital can eventually be regained over time, the years spent getting back to your starting point simply cannot be replaced. This reality prompted an email from a colleague earlier this week with respect to “the math of loss.”

During ebullient periods in the stock market “investment risk” is disregarded in the pursuit of gains. It is during these times where markets “only seem to go up” that statements such as “investing is about ‘time-in’ the market rather than ‘timing’ the market” are made. Such statements are generally regretted in the not-so-distant future.

There is a major point of clarification that needs to be made here. I completely agree that investors can not be “all in”or “all out” of the market on a consistently correct basis. However, it is at this point in the discussion that some analyst pulls out a chart showing how poor your investment returns would have been if you had missed the “10-best days in the market.”

While that bit of information is true, what is never discussed is the what happens to investor returns when they capture market losses. The table below shows the damage done to an investor’s portfolio during a market draw down and the subsequent return required to get “back to even.”