We think the prospect of rising [interest] rates should not scare investors for two reasons. First, rates will only rise when the economy is growing more strongly. In addition to better overall indicators, second quarter sales growth for S&P 500 companies is on track to climb 4.3% from last year’s second quarter, the strongest performance since 2012’s first quarter. This is a very positive sign as top-line sales growth will support bottom-line earnings growth, leading to higher stock market valuations.
Second, the market’s concern reminds us of a child who throws a temper tantrum because he doesn’t want to take his medicine. But will the medicine be that bad? We suspect that once the Fed raises rates, the level where they settle will be quite low by historical standards. With inflation running about 2%, we do not suspect the [federal-funds] rate will increase much beyond the same reading. A 2% [federal-funds] rate would likely mean a flattening of the yield curve so that not all of this increase would find its way into long-term rates. While auto and housing loans would be more expensive, they would still be quite affordable by historical standards.
As growth investors, we are hopeful that times are indeed getting better so that companies can grow their earnings and extend the bull market.
Note: Daniel J. Boyle is vice president at Provident Investment Management. The above is excerpted from Provident Investment Management’s newsletter.