Posted by Mark Eshman
Volatility has returned. Confusion over when and how the Fed will end it's QE has become a parlor game on Wall Street.
Diane Swonk, chief economist at Mesirow Financial had what I think was the most rational comment of the week when she noted, "taper does not equal reversing policy."
Bernanke has not only indicated as much but the Fed has already indicated exactly how their QE exit would occur. Whether or not they can do so with such precision is a completely different question.
For now, we're in a Goldilocks environment: the economic news is good, but not so good that the Fed is worried about slamming on the brakes just yet. Economist Ed Yardeni was quoted last week saying "the stock market is open-minded to the idea that they (the Fed) may be able to make a smooth transition if the economy continues to perform better."
To date, the Fed has communicated its intentions extremely clearly, and there is every reason to believe that when the taper and the ultimate exit begin, Bernanke will let the world know each and every move.
All that said, last week's action suggests that the bond market is jittery. Some of the significant outflows in high yield and mortgage-backed securities can be chalked up to traders finally realizing large unrealized gains, but I'd assume a chunk of the selling is coming from trigger-happy investors who, still smarting from portfolio losses during the financial crisis, are concerned that they'll be too late to the selling party.
If the Fed is true to its word, and if we're reading the economic tea leaves correctly, it seems that the market is overestimating the velocity of rates moving to higher levels. As Gary Cohn, COO of Goldman said last week, "When you get a fundamental shift in rates, which doesn't happen very often, the initial move is always pretty dramatic...people try to get ahead of it."
His partner Gary Beinner, CIO of fixed income at GS noted "the magnitude of the moves was extreme and wasn't based on fundamentals. It may have been based on a liquidity-driven event, with hedge funds selling when prices fell to target levels."
Finally, Beinner commented that he thinks merging market debt is still cheap and that investors should also look to floating rate corporate bonds. I agree, thanks to low cost and liquid exchange-traded funds (ETFs), these investments are avialable to everyone.
This market volatility may continue, but worrying about whether or not the Fed is going to "taper" anytime soon is a sport best left to professional investors. For the rest of us, if we continue to maintain a diversified portfolio of all types of stocks and bonds and keep our eyes on the long-term, we'll achieve our financial goals.
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June 5, 2013 | 1:47 pm
Posted by Mark Eshman
On the heels of a nervous pre-holiday week, we saw a strong sell-off in the markets last Friday, leaving many to wonder if we've seen the highs for the year. In fact, some investors are beginning to wonder if the bull market that has doubled the value of the S+P 500 since March of 2009 is finally coming to an end. While the economic news is, on balance, improving, some disappointing news releases coupled with stronger sentiment that the Fed will start "tapering" their massive bond buying program in the not-too-distant future have created a much more volatile investment climate.
After attending the Economic Club Of New York luncheon honoring Paul Volcker last week I remain firm in my conviction that low rates are going to be part of our investment calculus for a long time. In other words, we are in an era where stocks (and to a lesser extent, high income investments) will remain the only game in town not for months, but for years. Consequently, any market sell-offs should not be construed as the turning point that investors are shifting out of stocks and into bonds. Rather, investors are taking large profits and sitting in cash until they realize that there is no substitute for stocks.
Volcker noted that the history of economic deleveraging teaches us that rates can stay low (between 0% and 2%) for years. In the case of post-WWII America, rates hovered in a low range for 15 years! Lengthy periods of economic repair are necessary following big bubbles. These periods are almost always characterized by low rates and years of rising stock markets.
A good test of any investor is the ability to understand lessons from history and to apply them, hopefully proactively, before the tide shifts. In the case of the recent market action, it is clear to me that what we have been seeing these past two weeks is not a shift in fundamentals but something much more indicative of short-term trading.