Although the stock market is shattering records, and publically traded companies are more valuable than ever, much of Wall Street fears an upcoming “market correction." The general consensus is that September 2015 will mark the end of the Fed’s Quantitative Easing program, and the beginning of interest rate hikes (also known as the Federal Funds Rate). In response, investors are hesitant to invest capital in the stock market. In fact, many have decided to hold cash over securities. However, it is important to note that Fed Chairwoman, Janet Yellen, has yet to officially announce a change in monetary policy. Therefore, investors must decide whether or not a 10% market correction, in response to rate hikes, is “imminent” or a farce.
Firstly, investors must acknowledge that no institution on earth can precisely measure market sentiment (although the VIX volatility index is a good starting point). Given the current health of America's longest bull market (heading into its sixth year), it's easy for financial news sources to issue pessimistic views of consumer sentiment. While consumer sentiment reports make for excellent entertainment, the measurement is far too difficult to consistently gauge. Consumer sentiment is reliant on many variables and changes daily, and there are far too many additional independent factors driving market performance. Thus, by presently reacting to a predicted correction, investors believe the entire market will collapse due to raised interest rates. Nevertheless, there are plenty of variables that, technically, signal improving market conditions.
The foremost factor is the current state of oil prices. Generally considered a benefit to consumer sentiment, low oil prices often allow consumers to spend more money in other sectors, specifically retail. However, low oil prices have also been attributed to stock market volatility. Therefore, those who believe that low oil prices indicate an impending correction cite retail's recent dismal performance. Yet, these pundits fail to recognize that increased consumer spending requires 8-12 months for market absorption. As such, investors can expect low oil prices to be reflected in improved Q2 and Q3 performance reports. In other words, oil price volatility is a perfect example of why consumer sentiment is difficult to gauge.
The strong dollar is yet another independent factor affecting both consumer and market sentiment. In their most recent quarterly earnings reports, a number of companies, such as McDonald’s (MCD) and Pepsi (PEP), cited the strong dollar as the main reason for underperforming revenues and lower margins. In response to earnings misses, investors utilize perceived "corporate weakness" as a justifiable reason to sell stock. However, in the long run, the strong dollar should hypothetically benefit both international corporations and investors. A stronger dollar reflects a strengthening U.S. economy, rather than a reeling one, and affords consumers more purchasing power (buying more stuff for less money, especially abroad). If the U.S. economy continues to improve, and Q2 GDP vastly improves (Q1 growth was a measly 0.2%), investors will likely reinvest in traditional American companies.
Moreover, despite an inevitable rate hike, billions in new capital is already flooding the stock market. Hesitant investors have piled into successful companies like Apple (AAPL), which consistently exceed analyst estimates and generate above-average returns. Instead of trading "safe" treasury bonds and public/private debt, these investors continue to generate significant returns at only moderately higher risk. Even if the Fed increases interest rates in September, a number of companies, Apple included, are poised to provide returns that offset accompanied correction losses. Companies with solid, reliable dividend yields such as General Electric (GE), Cisco (CSCO), Blackstone (BX), and GlaxoSmithKline (GSK), will provide a consistent source of income regardless of stock market performance.
To be clear, a Fed rate hike is unavoidable. The question is how investors should shield themselves from a short-term economic downturn. Investors clearly have a number of trading options that will provide decent returns despite reeling market conditions; the trick is to find the optimal portfolio balance. Regardless of your choice, you must remember that any crash in response to Fed policy changes is purely speculative.