2014: What Will Happen Now?

What will happen now?  This is a vexing question on everyone’s mind.  Now that the Fed has signaled the end to at least the ultra easy money policy by systematically eliminating quantitative easing (QE), there are many questions on investor’s minds as to what will happen next.  Will the economy finally find it’s footing and take off?  Will that drive inflation and rates to new highs?  What will this do to the markets and real estate?  Are there any Black Swans out there lurking?

While it’s tough to have a crystal ball to figure out what will happen next, we can look at it from a risk/reward perspective.  Right now, with no major shocks to the markets in almost two years, many hedge fund managers are calling for one to happen in the near future.  But, most people do not think that will kill the bull market.  I tend to be in this camp.  Every once in a while, the market needs a new shock to wash out the weak buyers.  Also, higher rates, in and of themselves, do not kill bull markets either.  While this changes the perspective of many investors and the choices they make, a steady, gradual increase in rates should not choke off growth in the economy.

The most vexing question is whether the Fed’s ultra easy-money policy has created a Black Swan somewhere that we haven’t seen yet.  This could very well be the case.  As we saw in the summer of 2013, easy money excesses caused even the slightest ripple in interest rates to make enormous moves in currencies and emerging market stocks.  Unfortunately, without that crystal ball, it could be in any number of areas, including those emerging markets, high-yield debt, or our old friend, real estate.  So, hold onto your seats, it’s about to get interesting.

Is This The Top for 2013?

Wednesday, the Federal Reserve will decide whether or not to cut back on their long-lasting quantitative easing policy. What does this mean and why should you care? This could drastically affect the low interest rate cycle that the equity market has been built upon since the end of the Great Recession, which basically marked its lows in the spring of 2009. So, could this be the top for the stock market? After a four-year bull market, changes in everyday interest rates, including many types of loans, have risen substantially. While consumers are already feeling the pain in items such as mortgages, the stock market has largely taken this move in stride and is closing in on its 2013 highs as of this week. Also important, this also changes the cost of capital for businesses around the world.

While the Fed is not officially changing their stance on interest rates, a cut back in the amount of bonds the Fed buys each month will essentially mark a change in policy. This new policy may change the landscape and here’s why: When longer-term interest rates begin to rise, this can make yields on certain bonds become more attractive. Since US Treasury Bonds are inherently less risky than stocks, and because the US government has a very low risk of default, this at least makes certain investors consider bonds as opposed to a riskier agenda of stocks. For the last four years, the choice was easy. With short-term bonds essentially yielding nothing, and the risk of the financial collapse falling further and further into the past, many stocks had higher yields than bonds. Plus, investors had the upside of price appreciation with a stock. Now though, with stocks more than doubling from their lows, there are few people that would tell you that they are the bargains that they were during the panic. In an ultra-low interest rate environment, the choice was pretty easy. Now, the market becomes more complex.

There is a further risk that the Fed created certain asset bubbles due to these low rates and we will only find out what skeletons are in the closet, once rates move up. This is the so-called, Black Swan effect, made popular by Nicholas Nassim Taleb in his best-selling book of the same title. Essentially, this phenomenon happens when no one expects it, and it occurs often in an emotion-driven vacuum like the stock market. Just because it’s never happened before, doesn’t mean it can’t, as we saw in the real estate collapse. A possible spot for this could be the bond market. Naturally, as stocks collapsed during the panic, a natural, safe landing spot for capital was the bond market. Now, longer-term bonds are falling apart as interest rates rise. Investors piled into bonds by the masses and now are feeling the effects. Another concern is emerging markets and the foreign exchange markets associated with them. As the Fed becomes more hawkish and capital is treated better here in the US, there have been massive outflows of capital from places like India and this has many worried. While I am not calling an end to the bull market quite yet, investors should at least start to become more wary. The ground under our feet is beginning to shift. These are the types of issues we examine at Financial Advisor Austin Wealth Management. For more information, visit our site or check out this post on Seeking Alpha.

Jobs Number: Nail In The QE Coffin?

Now that the all-important August nonfarm payroll report is in, the speculation can really begin about whether the Fed will begin to ease their multi-year run of quantitative easing strategies.  While most observers were expecting 180,000 new jobs, only 169,000 were created in August.  This at least opens the debate as to whether Ben Bernanke and the rest of the Fed governors will vote at their September 18th meeting to end or more likely, cut back on their QE strategy.  Despite an official 0% interest rate policy, QE has kept many other market-driven rates low.  Without this QE phenomenon, rates such as the 10 year treasury bond, have seen over a 100 basis point increase over the last few months, since the Fed hinted back in May that the economy may be improving and this policy may no longer be needed.  While new home starts have stumbled, as mortgage rates moved from lows near 3.5% to almost 5%, the stock market has taken this move largely in stride.  Although longer-duration bonds have been pummeled, the real question is where we will move after the Fed makes its decision and how large of a move that will be.  Fed fund futures moved 4 to 5 basis points lower, depending on the futures contract.  Many Fed watchers believe with Mr. Bernanke on the way out, he has enough ammunition to at least put a cap on his legacy and begin the wind down of the program.  So, the question is, is a gradual end to QE largely priced in, and what happens if they decide not to move in September?  To bulls, will this mean another run at and over this years’ highs, or will a definitive taper send markets sharply lower?  On time will tell, but there should be some interesting opportunities for trades on either side of this Fed meeting.

Fool’s Gold or Here To Stay?

Now that the Dow has more than doubled from its low of 6,443 on March 6th, 2009, it’s probably a fair question to ask if it’s a good idea to keep putting fresh money to work in this market.  The bulls would say the conditions are still very good.  Interest rates are still very low and the Fed is still in a an accommodating position.  The bears say the ground is beginning to move a bit.  Longer-term interest rates have moved up more than a 100 basis points just in the last two months once Mr. Bernanke made a mere mention of any kind of decrease in QE.  While we’ve had scares over the last few years, including European problems and S&P downgrades, this is at least a little different.  Interest rates do in fact rule the world, so when they move, we should at least start paying attention.  While there is plenty of research to show that increasing interest rates at this stage of the cycle can still mean higher equity prices, we always need to keep in mind that past results are not always indicative of future results.  It has been discussed that much of the buying from this latest 6% downturn has been from retail investors, as many institutional investors are out for the summer or in light trading modes.  Just something to think about as many just blindly hand over money to the market in hopes that this 4+ year-old bull market has much more, in terms of upside legs.  Things have at least gotten a little more interesting…

Bulls, Bears, & Pigs

While the equity markets may reach new, all-time highs here in early February, it is starting to make me nervous that the media has suddenly turned so incredibly bullish.  We’ve seen this story before either in past bull or bear markets.  When the news is good, there is barely a negative story to be found on CNBC or in other parts of the financial media.  I just wonder whether or not once we inevitably reach new highs and flush out all the stops just above the new highs, will there be any new buyers to push the market higher?  Or, will the market be completely overextended and hit the wall this spring, just like in the previous two springs?  While I think we continue to climb the wall of worry, it seems like we might be reaching at least a short term top, just above the all-time highs.

The Fiscal Cliff

While most were worried about the potential downsides of $500 billion in spending cuts and tax increases right after the election, markets have seemed to price in the exact opposite in mid-December.  Markets seem to be pricing in a deal, and once that deal is done, a potentially big upside once the deal is done.  Now that Christmas is nearly here and deal is still not in sight, markets have sold off a tad bit.  I believe this could be the age-old case of buy the rumor, sell the news.  Almost no matter what happens, there is sure to be a bit of austerity coming to the U.S. economy, much like we have seen in Europe, though not to that level.  Either way, I’m not sure the fiscal cliff deal is pro-growth, in as much as the latest Fed actions are.  The question is, can the Fed continue to save the economy while politicians seem to do everything in their power to destroy it? While economic numbers are trending toward the better these days, anything that shrinks the spending power of the government during this time cannot help the bullish cause, no matter how much we believe some constraints on government spending is eventually necessary.

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