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Bob’s View: Markets at midyear

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By Bob Landaas

At midyear, stocks in the U.S. are up 3% against a backdrop of economies that are growing modestly around the world.

After a disappointing start to the year with the U.S. economy held back by one-time events, growth resumed in the second quarter.

  • The U.S. labor market is strong, with jobless claims remaining at 15-year lows. Consumer spending jumped in May – the best gain in six years.
  • New home sales rose to a seven-year high in May.
  • The Commerce Department reported recently that business spending rose an encouraging 0.4% last month.
  • The manufacturing sector, which accounts for 12% of the U.S. economy and has been held back by a stronger dollar and cutbacks in the oil sector, has shown recent signs of improvement.

Globally, stock markets continue to experience headwinds with Greece and the impact of rising rates by the Federal Reserve. A Greek default and its potential exit from the eurozone have created uncertainty in the financial markets. With their deadline at the end of June rapidly approaching, resolution should be forthcoming.

The Federal Reserve has been the source of endless speculation.

In each of the last four years, we began the year being told that the Fed would raise rates by late in the springtime. As the summer months approached, we were again told that the Fed would raise rates perhaps later in the year. And with the approach of a new year, we began the saga all over again.

The effect on stocks of an interest rate increase is up for debate. If interest rates rise because the economy is healthy, then the markets should experience little disruption. If interest rates go up because inflation is climbing dramatically, then the markets could experience a sell-off. Recently, the Labor Department reported that core consumer prices rose only 0.1% in May, suggesting very little inflation.

Given the anemic growth of the U.S. economy, investors might be making too much of the Fed’s plans to raise interest rates.

It is now widely expected that the Fed will raise short-term interest rates by 0.25% at least once in the fall of the year. Bond yields have already reflected this potential rate increase. The yield on the 10-year Treasury has climbed from 2.18% in the beginning of June to 2.48% now in anticipation of higher rates.  When the Federal Reserve acts, I do not believe that it will be disruptive for stocks.

While the forward P/E for U.S. stocks remains a little expensive at 17.5 times forward earnings, operating earnings for this year and next are expected to climb 7%-8%.

What will matter more to stocks is economic growth and earnings growth, not higher interest rates.

Many forecasters expect the U.S. economy to grow 3% in the second half of 2015 with slightly higher growth expected for next year.

If stocks climb another 3% in the second half of this year, along with 2% in dividends, we should wind up with a pretty good year for the markets.

Bob Landaas is president of Landaas & Company.

(initially posted June 26, 2015)

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