Rate Hike Warning Causes Markets to Freak Out and Tank

Armed with positive data about the economy, Fed officials this week put forth the possibility of a rate increase as early as June. And guess what happened? Stockholders who’ve been riding a wave watched as the S&P promptly lost any gains for the year.

The Wall Street Journal notes the Dow marked its third session of declines and its longest losing streak since February at market close Thursday. Both indexes were about five percent below their intraday highs this time last year, and the Dow closed down a hefty ninety-one points. The Nasdaq Composite index, which hasn’t closed in positive territory for a year, closed down almost twenty-seven points.

This fainting spell in equities markets clearly represents investors’ anxieties about the ramifications of a rate hike. When the Fed raises rates, banks will follow suit by raising the rates they charge their customers to borrow money. The perception, or I should say the fear, of investors is the companies in which they own stock will cut back on expansion if it costs them more to borrow. It’s no accident financials were among the sectors that took a hard hit on Thursday.

In addition, rate increases curtail consumers’ disposable income because mortgage lenders and credit-card companies will charge higher rates. When consumers cut back on spending, businesses’ bottom lines suffer. In turn, stock prices and dividends suffer when this happens. There are vicious circles; call this a ferocious circle.

All this has rankled investors, who had been enjoying a sweet equities run for a long while as interest rates have remained low.  What’s curious, though, is they were taken by surprise. Yes, it’s true the Fed voted nine to one in April to keep rates unchanged. But the minutes of its most recent meeting in late April made it clear that, if presented with encouraging economic data, the Board of Governors would probably approve a rate increase at its June 14-15 meeting.

I think we’ve gotten too accustomed to a media that keeps double-daring the Fed to raise rates. Just maybe, come June, we’d best fasten our seat belts.  Thursday’s tizzy also puts the lie to the general assumption that the market had long since accustomed itself to at least a small rite hike, “pricing it in,” we thought.

But you can’t say investors didn’t have abundant clues as to the fragility of the market. Stock analysts have been talking about weak earnings for months now. Back on March 31, Mike Thompson of Capital IQ told CNBC’s Squawk Box:

“The precipitous fall in earnings expectations for the first quarter has been ‘stunning,’ and the post-March picture is not looking good….Right now we’re looking at down almost 3 percent [year over year] for the quarter. Most of that is energy, which has continued to degenerate, down almost 63 percent….”

In addition, we’ve all read the warnings from renowned hedge-fund billionaires like George Soros, Stanley Druckenmiller, and David Einhorn, to name only a few. These gentlemen have publicly counseled investors to sell our stocks and buy gold. They believe that the actions of world central banks, including our very own Fed, are wrongheaded and, worse, harmful.

It seems the time to try second-guessing what the Fed will do about interest rates is long past.  If Druckenmiller, Einhorn and company, who all, tellingly, made their moves into gold well before this “Fed freak-out,” have anything to teach us, it’s that this is the calm before the deluge.  And the fact is, while we don’t get many of the advantages available to the super-wealthy, we do have equal access to gold.  In this one case we can do as they do, protect our wealth and our retirement security.

Gold is a tangible asset that will increase in value over time, and its historically inverse relationship to plunging markets and the dollar certainly also provides peace of mind at a scary moment. When the Fed makes good on its threat to start raising rates, you’ll have an inflation hedge and protection of your remaining dollar-denominated assets.