Fed Pares Back Bond-Buying Program to $75B
The FOMC on Wednesday, December 18th, 2013 agreed to softly pare back its QE asset purchases by $10 billion, taking the first step in unwinding its controversial bond buying program. The market is shifting from a yield driven one to a growth cyclical one now that we are in 2014.
As 2013 closed-out, investors anticipated the changing market environment in 2014. Despite the stock market reaching all time highs throughout the bull market from 2009-2013, many investors have serious concerns and doubts about the future. Every bull market poses the question about the next bear market. I don’t see the bears showing-up in 2014. Excellent years like this one are followed by good ones.
How long will this bull market last? Some research reports show that the markets could continue to rally through 2015. However, after that predictions are not so promising. The economic data shows that while it may be doing so grudgingly, the economy is growing.
In June of 2013, the chairman of the Federal Reserve, Ben Bernanke, announced that the government would begin tapering quantitative easing (the government increase of cash flow in the economy via its bond buying program). The announcement caused a dramatic spike in interest rates very quickly. This may have suggested that the end of quantitative easing will impact borrowing costs and lending rates rapidly. As the Fed begins to taper, investors should be aware of their investment valuations in an environment of rising rates. Investors should protect their equity profits and hedge their fixed income portfolios.
In a more positive light, 2013 did show an uptick in the housing market, which is typically a sign of economic growth and stability. The National Association of Realtors predicts home prices will continue to increase during 2014. The average price of homes rose about 11 percent in 2013. That figure is expected to approximately increase by another 6 percent in 2014. This is a sign that the American economy has exited stages of recession. There is typically a positive correlation between growth in the housing market and growth in the stock market.
Overall, 2014 will pose some challenges for investors. The uncertainty of the effects associated with the tapering of quantitative easing can be a daunting thought for investors to confront. However, investors should continue to monitor the housing market and other economic indicators such as employment and U.S. consumer and producer price inflation which could reveal economic growth. Though the road to economic recovery is slow, the financial crisis of 2008 is clearly in the rear view mirror and investors should review their portfolios often while attempting to mind their exuberance and maintain a realistic level of optimism.
At present, the Fed says as long as its own forecast of inflation stays below 2.5% it won’t even consider Fed Fund rate hikes until the unemployment rate hits 6.5%. I think the Fed would get more economic bang for the buck from this forward commitment if it cut the jobless threshold to 5.5% instead. The theory is that by committing to a longer time period for a zero federal funds rate, the Fed could hold long-term interest rates down, which would stimulate the economy.
In other words, the Fed could have a way to move forward with tapering and, in its own view, loosen monetary policy at the same time.
The Fed is, in effect, admitting that quantitative easing was never the reason long-term interest rates fell in the first place. It wasn’t the amount or make-up of bonds the Fed was buying that mattered; instead, quantitative easing was just a tool the Fed could use to signal how long that short-term rates would stay at zero. The more securities the Fed would buy and the longer it committed to buying them, the longer it would take to end those purchases, which meant the longer it would be before the Fed finally got around to raising short-term rates.
Fed policy should continue to provide a tailwind for stocks and I continue to have a positive view toward equities. I believe investors should continue to overweight stocks in their portfolios.
Although stocks have been hitting record highs, flows into stock funds have moderated a bit in recent weeks. In the fall, I began to see outflows in higher-risk areas of the market, such as from emerging markets funds. These moves suggest that the magnitude of the recent rally has prompted some investors to engage in selling and profit-taking. I believe that emerging and developed markets in Europe will rebound in 2014 and join the U.S equities parade. I favor a weighting in Japan equities as well.
In 2014, perhaps the new in-vogue Wall Street language will speak of “minor tapering”.
I’ve made this statement many times with clients: “You never lose when you take a profit.”
As we greet the arrival of 2014 financial markets, I borrow the famous dialogue from the movie Trading Places: “Looking good, Randolph! Feeling good, Mortimer!”