Resetting Investor Expectations With Upcoming Interest Rate Hikes

We are getting close to the first rate hike since the 2008 meltdown and all expectation is that Dec 14/15 will see the rate hike become a reality. The Fed expects the hikes to be gradual after this. However, this signals a change in the business environment and investors need to be aware of this.

Capital will flow back into US from the emerging markets as yield chasers will start returning.

The broader investor capital will likely be deployed in a wider variety of asset classes. So far this year, most of the market returns have come from a very narrow list of high growth/momentum stocks while value has been left behind. This situation will start correcting.

The possibility of reflation will make smaller companies more profitable. The businesses that have debt from the low interest rate times will enjoy 2 benefits: a) higher return on capital being used to pay back low interest rate debt, and b) a decline in the real value of the debt.

Since 2009, small cap value stocks have under performed the broader stock market. This has been a long run of under performance which is not in line with the historical record. Rising interest rate environment generally means the small caps and value stocks regain their performance edge and I expect this to happen starting December.

Global Trade and Emerging Markets

We have seen emerging markets slow down considerably this year led by a slow down in Chinese economic growth. With the increase in US interest rates, some of the capital flight from the emerging markets will only become more dire. This current decline has hurt the commodities demand and I see some of this persisting in 2016 although when the production cuts are instituted and the glut of the commodities in the market is reduced, the pricing power in commodities will increase.

If you consider the Baltic Dry Index (BDI) as a leading indicator of global trade, it is very close to its all time lows. This indicates that the demand for the ships being contracted out in the next few years has been very low compared to the ships available. We do have some over supply in the ships today but it has not really worsened in the last few years. We are seeing a slow down in global trade activity which is likely to persist in the near future.