As we enter the final month of the year, stocks (as measured by the S&P 500) have made little progress for the year. Unfortunately, many hedge and mutual funds are lagging well behind on a year-to-date basis which is putting pressure on them to chase performance. 

With the Federal Reserve now set to tighten monetary policy for the first time in a decade, while every other country in the world is in a race to negative rates, the risk to investors has risen markedly. This is particularly the case given the downward pressures on economic growth from low oil prices, a surging dollar and weak consumption trends.

However, while the underpinnings of the market and economy have significantly deteriorated, it has not impacted the always optimistic views of Wall Street. Expectations for a continued bull market into the future remain firmly intact. As I stated earlier this week:

“Just this year there has been a rising number of articles suggesting that we have once again entered into a ‘Goldilocks Economy.’

The problem is that in the rush to come up with a ‘bullish thesis’ as to why stocks should continue to elevate in the future, they have forgotten the last time the U.S. entered into such a state of ‘economic bliss.’ You might remember this:

‘The Fed’s official forecast, an average of forecasts by Fed governors and the Fed’s district banks, essentially portrays a ‘Goldilocks’ economy that is neither too hot, with inflation, nor too cold, with rising unemployment.’ – WSJ Feb 15, 2007

Of course, it was just 10-months later that the U.S. entered into a recession followed by the worst financial crisis since the ‘Great Depression.'”

The problem of suggesting that we have once again evolved into a “Goldilocks economy” is that such an environment of slower growth is not conducive to supporting corporate profit growth at a level to justify high valuations.

Such a backdrop becomes particularly problematic when the Federal Reserve begins to raise interest rates which removes one of the fundamental underpinnings of an overvalued market which was low interest rates. Ultimately, higher interest rates, particularly in an economy with a deteriorating economic backdrop, becomes the pin that “pops the bubble.”