Where to invest when the Fed does begin tapering
Worry and speculation have consumed investors since U.S. Federal Reserve Chairman Ben Bernanke spoke to Congress last month about the central bank’s drive to keep long-term interest rates at record lows. While the Fed chose to stay the course on Wednesday, the question remains: will the Fed begin tapering its $85 billion-a-month in bond purchases within “the next few meetings,” as Bernanke suggested during his remarks to Congress? Or does the job market remain too weak for the Fed to slow its stimulus, as Bernanke reiterated after today’s FOMC meeting? The Fed’s bond purchases have been intended to hold down long-term loan rates to induce Americans to borrow and spend and invest in the stock market. Ultra-low rates are credited with helping fuel a housing comeback, supporting economic growth and driving stocks to record highs. Jill Cuniff, president at Edge Asset Management, spoke with Bloomberg Television about how investors can prepare for Fed tapering. Watch the full interview below.
U.S. stocks fall sharply on Fed tapering worry
U.S. stocks dropped sharply on Thursday, along with Asian and European equities as well as gold prices and bonds after the Federal Reserve signaled its bond buying could be scaled back later this year. The Dow Jones Industrial Average declined 129 points, or 0.9%, to 14,984 and the S&P 500 index slipped 17.88 points, or 1.1%, to 1,611.08. The Nasdaq Composite fell 38.32 points, or 1.1%, to 3,404.69. Stocks in Shanghai fell nearly 3% after a Chinese purchasing managers’ index hit a nine-month low. European equities also posted steep losses, with the U.K.’s FTSE 100 index down 2.2% in intraday trade. In the commodity markets, August gold futures tumbled $80 to $1,294 an ounce on the New York Mercantile Exchange.
The smart way to invest with the Fed
Hindsight is always 20/20. Fortunately in the world of investments, there are times when foresight can also come close to being 20/20. Ben Bernanke’s testimony before the Congress on May 22, 2013, was one of those times. In a similar fashion, the Federal Open Market Committee’s (FOMC) and Bernanke’s press conference Wednesday will simply sharpen the foresight for the clear-eyed investor.
I illustrate the point with five annotated charts in the sections below.
Tapering is not if but when
The Federal Reserve has been buying about $85 billion of securities per month. The Fed cannot continue to expand its balance sheet at the present rate. It has been obvious to me for a while, but the markets appeared to be taken by surprise when on May 22, Bernanke indicated that the taper may be coming.
The taper genie is out of the bottle and cannot be put back. The question is not if but when the taper will start.
Tapering is not tightening
In my analysis, the job ahead for the Fed is to clearly communicate to the markets that tapering is not tightening monetary policy. As an example, if the Fed reduces its purchases from $85 billion per month to $65 billion per month, the Fed will still be easing though at a slower rate.
Monetary tightening means an increase in benchmark interest rates. The Fed has clearly communicated that it will keep interest rates low until it reaches its target of unemployment rate of 6.5% and inflation stays below 2.5%. For reference, the unemployment rate in May was at 7.6% and the Fed’s preferred inflation measure increased in April by 0.7% below the 2% target.
How to Invest in the Fed’s Slow-Growing Economy
What if the “breakout” economy does not deliver faster growth and the “new normal” of slow growth and ultra-low interest rates is here to stay? Kevin O’Brien, who manages the Prospector Opportunity fund, says he sees “a lot more reasons” to believe the economy will maintain the status quo for some time to come.
Investors are watching the Federal Reserve for any disturbance in the established pattern of low interest rates now in its fifth year. The market has been shaken recently by concern that rates will rise as the inevitable full-strength recovery arrives. O’Brien says there are no strong signs that a big change is in the works that would lead to such a momentous Fed shift.