Investors spend a lot of time worrying about the Fed raising rates too quickly (causing a recession) or not quickly enough (allowing the economy to overheat with runaway inflation). The below article details why investors should worry even if the Fed gets it exactly right. In this so called ‘Goldilocks Economy’ (still lower unemployment with manageable inflation), companies will still have to deal with higher rates (slowing demand and sales growth), and higher labor costs given the ultra-tight labor market. This means companies aren’t likely to expand profit margins from current historically high levels.
Given where valuations are (16x forward earnings), this may be a problem. The benefits of the tax cuts to profit margins will roll off starting in the first quarter of next year. After that, companies will be hard pressed to beat expectations, and even with a still healthy economy, the market may be in line for lower valuations overall.
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Jeffrey Viksjo, CFA