April 2014

Tug of War

The performance of the financial markets seems to be tied to the outcome of an ongoing game of tug of war between a couple of powerful forces.

On one side are increasing interest rates. After years of keeping interest rates low to stimulate spending -– and therefore economic growth -- the Federal Reserve has made clear that it intends to start increasing rates slowly until they are back at more normal levels.

At her first press conference, held last month, new Fed Chairman Janet Yellen suggested that the Fed could begin raising interest rates as early as the spring of 2015. Somewhat predictably, the Dow fell 100 points on the news.

However, it rebounded based on good news about corporate earnings, which set another record in 2013 and seem to be continuing strong. A recent Wall Street Journal article noted predictions of continued double-digit profit margins in 2014. The same article, though, added that such early predictions often prove unrealistically rosy.

Of course, there are other things that can have an impact on the markets. The recent Russian movements in Ukraine and Crimea made investors very jumpy, for example. Reports on consumer confidence, durable goods orders, housing starts and employment also make an impression. But at the moment, the two main opposing factors seem to be interest rates and corporate profits.

The concern with rising interest rates, of course, is that higher rates will make it harder for companies to borrow money for expansion and will make consumers less likely to spend money on things companies produce. Most economists believe that much of the recovery from the Great Recession was fueled by consumers who were willing to buy things ranging from TVs to cars to homes because credit was cheap.

As for corporate profits, markets always rise or fall based on earnings and the expectation of earnings. When earnings have been strong -- especially over a long period of time -- the markets almost always are up. Companies that have strong earnings have more money to hire more people, buy more equipment, expand operations and generally prosper.

So in this tug of war between rates and profits, which side will win? It looks like, in the short term, it could be kind of a draw. One side prevails for a time, then the markets react to news from the other side. If the Fed raises rates slowly and the economy adapts well to the new rates, that could lessen the negative impact of the increase. On the other hand, if corporate profits flatten out, that could tamp down the markets' enthusiasm for growth.

At Peachtree Investment Partners, we don't believe in trying to predict the future. Instead, we believe in following an investment approach that looks toward the long term. We invest in the stocks of large, stable U.S. companies, because we think those companies are best-positioned to weather most storms. We also prefer stocks that pay dividends, which we think serve both to ease volatility and to add to income, and therefore to overall returns.

We believe that taking that approach offers the best opportunities for success -- whichever side of the tug of war rope ends up over the line.

Garry K. Schaefer
Atlanta, Georgia
April 8, 2014

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