As the U.S. economy continues to show signs of strength relative to most other regions around the globe, the trade-off for investors can be found in the prospect of higher interest rates. In most cases, this would suggest reduced expectation levels for corporate earnings. But there is historical evidence which suggests this might not actually be the case this time around.
In any event, investors and consumers will need to position themselves for a changing market environment. The monetary policy course at the U.S. Federal Reserve is unfolding in ways that were not expected in the early parts of this year.
Recent GDP figures suggest that the U.S. economy is now expanding at a rate of 4.1%, which is the highest level in nearly four years. Consumer spending levels remain healthy, and Budget Tracker tools suggest that this is likely the result of better spending practices for households. Most of the evidence suggests that we will continue to see economic expansion in the quarters ahead. But it is critical to position for potential downside in case we see market activity that is similar to what was experienced during the major declines in February.
Some of the possible headwinds markets might face could come as a result of tighter interest rate policy at the Federal Reserve. Most accepted economic theory suggests that higher interest rates tend to reduce credit spending over time. This can place a draw on corporate earnings and then, by extension, on share prices themselves.
We are still trading at elevated levels in the NASDAQ and in the S&P 500 and this presents added risk for reversals any time we see negative earnings numbers from stocks that are closely watched by the markets. Recent examples of this can be found in Netflix
In terms of trade positioning, options strategies look very attractive here. Options contracts allow investors to capture the benefits of upside momentum in stocks without adding to the downside risk exposure that can come with the “flash crash” types of moves that we seen in the earlier parts of this year. This means that call options in instruments like the SPDR S&P 500 Trust ETF
Of course, we are still trading in the summer period which is a time that is typically market by reduced liquidity and trading volatility. In most cases, this translates to sideways market activity but there are also many examples of situations where this can actually lead to increased volatility. In any case, this is certainly shaping up to be an interesting next few months in the financial markets!
