The pull back in the stock market has primarily been driven by the rate rise over the past couple of weeks. The 10 year Treasury bond yield passed through 3.0% and hit 3.25% the first week of October. Since then, the markets have been acclimating to what is being called the “new norm” for rates, meaning that we are migrating to a higher rate environment for the first time in nearly 5 years, when the 10 year Treasury reached 3.02% in December of 2013. As of today, the rise in rates has subsided as markets assess where we are. Following Trumps’s comments, the Fed may or may not rise rates again in December, however the truth is that the Fed does not give any relevance (historically) to comments made by the President or the administration, meaning that we may likely see rates rise again in December.

Rates are heading higher because the Fed has stopped buying government and mortgage bonds in the markets, and instead is selling bonds….this is a form of tightening in order to stem inflationary pressures. As long as the tightening is gradual, the equity and bond markets will be able to tolerate moderately increasing rates.

Adding to the Fed’s actions, economic activity is increasing, with inflation becoming more of a factor. As the economy as strengthened and the unemployment rate has fallen to below 4%, we finally have higher wages leading to rising prices for practically everything. Remember that the single largest expense for nearly every U.S. company is labor costs, which directly affects their earnings and how much more they may charge for their products and services.

What is occurring now is a replication of a dynamic that has happened before many, many times…..it is a cycle. Optimistically, this cycle is due to a healthy and expanding economy, as rising wages provide more money for workers/consumers to spend on everything from furniture to groceries. A little inflation is good, but too much can be bad for companies and consumers.

Rising rates are very bad for companies that hold large amounts of debt and need to constantly issue debt (borrow money) to stay afloat. I don’t like or buy companies as such, and only consider companies with strong balance sheets and ample cash flow, such as various large cap growth and large cap value holdings.

I’d say that this is a temporary occurrence until the markets acclimate to higher rates and we see the release of company earnings over the next few weeks. The effects of the tax cuts and rising earnings are still very favorable and influential, meaning that we will most likely see the markets continue to head higher over the next few months.

Feel free to call with any questions or concerns.

Thank you.

Alex