“Market volatility may increase in the short term. It almost always does with policy change. But, the end of Q.E. will mean that, longer-term, things are getting better, not worse.”
~Capital Allocation & Management Market Brief, June 17, 2013
Most of us have taught our children to ride bikes. They start with training wheels, they gain confidence and then, eventually, they make the leap to riding on two wheels. As just about all parents who have gone through this exercise can attest, the feeling of joy and pride when they finally “get it” can’t be measured.
For our kids, at least, the hang up on getting them riding without training wheels was mental. They had what it took to ride, but they were afraid. “What if I can’t?” “What if I fall?” “It’s scary.” They were afraid of what might happen because they were facing the unknown, and if it didn’t work, they might get hurt. At the end of the day, though, they wanted to ride their bikes, and they knew that the inevitable day of riding without the little wheels that propped them up was coming.
Last Wednesday, the Federal Reserve tried to prepare investors for the inevitable day when the training wheels provided by quantitative easing (“QE”) would come off. They didn’t say that QE was going to end imminently, and they didn’t set a specific date for its wind down. As they have done before, though, they did confirm that one day it will come to an end.
The QE wind down is not dependent on a date. Rather, it’s dependent on a set of conditions. Specifically, the Fed has vowed to keep QE and other accommodative policies in effect until the unemployment rate approaches 6.5%, so long as inflation doesn’t move above about 2.5% annually.
Markets have been reacting negatively to this news since May when Fed Chairman Bernanke first hinted at the prospect of tapering QE. Stocks have sold off, particularly non-U.S. stocks and interest rate sensitive sectors like utilities. So have bonds and commodities. This has been especially bothersome for many diversified investors, since historically bonds have tended to rise as stocks fell. The fact that the end of QE will likely be accompanied by rising interest rates has been the main reason for the recent decline in bonds. We attribute uncertainty as the main culprit in the sell-off in stocks.
As we said last week, though, the end of QE will most likely mean that the economy is getting better, not worse. In a very real sense, traders (not investors) have come to believe that QE is the only reason the market has gone up over the last four years. We don’t believe that. They are scared to see it end because they don’t know what will happen. “What if we fall?” “What if something bad happens?” Worry is natural, but it is also usually a short term phenomenon. One day, we will have to ride without training wheels afforded us by QE. It might scare us initially, but I bet we’ll be better off once we realize we can do it.
Source: Edited remarks of Kane Cotton, CFA, Bellatore Financial, Inc.