Monetary policy will be a major factor in market growth in the U.S. and around the world in 2016, according to experts at Charles Schwab. In its January 2016 market outlook, Liz Ann Sonders, Jeffrey Kleintop and others shared their views on the direction the market will take this year, noting that "unfinished business" from 2015 will lead to only modest gains.
The Federal Reserve finally raised interest rates in December, but the new question is how quickly rates will increase throughout 2016. Liz Ann Sonders, chief investment strategist for Schwab, wrote that a gradual pace of rate increases is likely a good thing for stocks.
Historically, in years when the Fed declined to raise rates at most Federal Open Market Committee meetings, the S&P 500 returned an average 10.8% in the following year, according to Sonders. When the Fed has raised rates at every or most meetings, the S&P 500 fell an average 2.7% the following year.
So, how fast can we expect the Fed to raise rates?
A key determinant, Sonders said, is the strength of the U.S. dollar. "A stronger dollar acts as a drag on the U.S. economy and hurts corporate earnings," she wrote. As long as the dollar remains strong, the Fed will likely stick to a slow pace.
Inflation is another important factor. Faster rate increases would suggest the Fed is trying to "combat an inflation problem or an overheating economy (or both)," Sonders said, neither of which is good for the stock market.
Overall, Schwab is taking a "neutral" view of U.S. stocks, Sonders wrote, noting that the stock market appears to still be in the "mature phase of a 'secular' (long-term) bull market."
Valuations are up slightly, and stock buybacks and dividend increases have contributed to the continued bull market, now approaching its seventh year, but weak earnings and higher borrowing costs could be a drag. Wider spreads between corporate bonds and Treasuries could also be a problem this year.
"The bouts of volatility that the stock market experienced in 2015 are likely to persist into 2016, driven by monetary policy divergences around the world and uncertainty about policy changes and economic growth," Sonders wrote. "That said, the stock market has proven to be resilient during this nearly seven-year bull market. In fact, investor sentiment remains a compelling argument for why this bull market is probably not on its last legs."
