Lehman Brother’s incomparable Jim "Fists of" Furey has some interesting comments out this morning on rising interest rates and their effect on small cap stocks:
"We believe Euro-area & Japanese weakness demonstrates what happens to industrialized economies when they do not pursue stimulative policies. It is our view that should the Fed tighten more than another 100 bp the US economy will suffer as a result of the absence of US demand amplifying Euro & Japanese weakness….Our point: the (yield) curve’s behavior, further tightening & soon to emerge talk of Greenspan’s replacement raises small-cap risk."
Once again, numerous commentators are expounding the benefits of rising short term rates – "it’s a sign of strength in the economy", "rates are still relatively low", etc. However, I think in an environment of rising global tensions, high oil prices and potentially higher taxes, adding higher interest rates to the mix is a definite drag on growth.
Balancing against those negatives, Jim also had some interesting comments about Chairman Greenspan…
"Current stock prices reflect actions nine to twelve months forward and Greenspan’s replacement will be front and center in late summer and early winter. Traditional risk
and inflation expectations measures indicate that investors are confident Greenspan’s successor will be every bit as competent as Greenspan in maneuvering markets, psychology, and the global economy and we are not so sure that as summer approaches that will be the case, particularly if the US weakens and follows other industrial economies."
A quote from Doris Kerns Goodwin is probably very apt in this circumstance…"Once a president gets to the White House, the only audience that is left that really matters is history." Similarly, Greenspan understands his place in history as presiding over the greatest post-war economic expansion in history and won’t do anything to damage it.
I think the "Greenspan Put" will be in full effect over the next two years. It’s improbable to me that Greenspan is truly in "auto pilot" mode when it comes to raising short term rates. I think the Federal Reserve will stop raising short term rates before the yield curve turns negative. And this should be a positive for stocks. Therefore, any serious corrections over the next twelve months should be bought, in my opinion.
However, once investors start looking to a future without Greenspan, the market could face some problems. Call it the "post-Jack Welsh hangover" – Welsh managed earnings to a tee to ensure General Electric (GE) stock stayed relatively high until his retirement in 2001. However, once he left, Jeffrey Immelt was left holding the assortment of low-growth financial businesses that took him three years to re-align. I think a similar fate could fall on the market as a whole as Greenspan enters his final year in 2006. However, until then, I think Greenspan will make sure his "Maestro" legacy remains in tact.