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Will less-friendly Fed snuff out stock rally? – USA TODAY

December 15, 2013 by · Leave a Comment 


The stock market has gotten a huge boost the past few years from the Federal Reserve’s unprecedented bond-buying program, known as quantitative easing, or QE. The policy is designed to bolster the economy by keeping interest rates low. But now that the economy is showing signs that it can grow without the help of Fed stimulus, the central bank is edging ever closer to dialing back on its $85 billion in monthly purchases of long-term Treasuries and mortgage-backed bonds. 2014 will mark a year of transition to a less-friendly Fed.

USA TODAY: What will the market impact be when the Fed starts to dial back on QE?

Savita Subramanian, head of U.S. equity and quantitative strategy, BofA Merrill Lynch: The net impact could be less negative than what might be expected. Tapering might be good news, in that it shows the economy is self-sustaining and less reliant on this consistent funnel of liquidity from the Fed. We could see a market rotation similar to what we saw from May to September, when we had a preview of what the impact of tapering might look like (when the Fed first hinted that tapering was coming). We got a little bit of a hiccup in the market, and we saw about a 5% correction. And that might be what we would expect in an actual taper scenario. The markets had some time to digest this.The taper appears to be almost inevitable, and it is just a question of when. We could see a sell-off and some volatility around it, but I don’t think that we will see a steep downside risk.

USA TODAY: What types of stocks will be helped or hurt when tapering begins?

Subramanian: The most predictable rotation is you see liquidity-driven plays underperform and economically sensitive areas of the market outperform. Investment plays that are driven by falling interest rates, such as high-yielding equities, or so-called bond proxies, will sell off. I would steer clear of retailers and consumption plays that benefit from falling rates. Rising rates may drive a shift from spending to saving.

MORE: Will 2014 be another slam dunk for stocks?

In contrast, you will see a bit of a recovery in some of the more GDP-sensitive sectors that haven’t seen much love or out-performance over the last five years. Rising-rate beneficiaries include tech, industrials and maybe, to a lesser extent, energy.

USA TODAY: Mega bears say the stock rally is an illusion, that it’s being propped up by cheap Fed money and that it will plunge once the Fed starts draining the system of liquidity. Is that scenario a possibility?

Nick Thakore, portfolio manager, Putnam Voyager Fund, Putnam Investments: I don’t think the market is built on Fed stimulus. It is built on all-time record corporate earnings that are sustainable as long as there is some growth in the world. My view on rising interest rates is, odds are the market can navigate it successfully, at least for awhile.

MORE: Winning investment themes for 2014

First, there is a lot of panic about rates, yet the 10-year Treasury note’s average yield is 3% from the market bottom in March 2009 to 2011, and we are not even back there yet. (The 10-year note closed at 2.87% Friday).

Second, the stock market actually does well when rates are rising from low levels, as these low-rate, low-inflation periods coincide with what historically has been the market’s highest P-E multiple. Third, the biggest thing we have to worry about with higher rates is housing and if that gets derailed. Our calculations are that housing affordability is so good right now that you could have home prices go up 6% a year for the next two years and the 10-year Treasury yield would have to go all the way to 6% for housing affordability to be average by historic standards. So, I don’t think that it will be derailed.

The final piece is you are unlikely to get higher rates without good economic news. Where I worry about rates is if they rise too far, too fast and if it comes with inflation, because that is a completely different ball game.

There is always the risk of unintended consequences. A lot of capital went into fixed income and asset-allocation strategies that were exotic. What happens when that gets unwound? For example, emerging-market currencies have been getting crushed as interest rates have gone up.

USA TODAY: How high or how fast must the 10-year bond spike — 3.5%, 4% — before rates really weigh on stocks?

Larry Robbins, CEO and portfolio manager, Glenview Capital Management: Let’s look at 2013 for the answer to that. From May 1st to today (Dec. 6), the 10-year Treasury went from 1.6% to 2.9%, and the S&P 500 stock index went up 14%-plus. Within that seven-month period, June was the month in which the bond market saw the most significant backup in rates and the stock market was negative.

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So, there is this initial shock about, ‘Gee, interest rates are rising. Is this negative for the market?’ There is likely to be a short-term psychological adjustment period, but I am in agreement that the march toward higher rates for the 10-year note is inevitable.

Yet, if you listen to what the Fed has said, they have two levers, one is fighting long-term rates through quantitative easing, or QE. But the other is by keeping short rates low. Again, if you look out to see when the market is pricing in the first rate hike, that would be in October of 2015. And you have to go all the way out to October 2017 before short rates are 2.5%. We think that monetary policy is likely to be easy all the way through 2017.

You won’t have this artificial quantitative easing in the form of asset purchases, but you still will have very low short-term rates. We don’t see tight monetary policy for as far as the eye can see.

USA TODAY: Is the stock market getting more accustomed to the idea of “tapering?” We had two “taper tantrums,” or market dips of 5% in 2013, but the market soared Dec. 6 after a strong jobs report, which all but cemented a Fed tapering sooner rather than. Is good news on the economy now good news for stocks?

Russ Koesterich, global chief investment strategist, BlackRock: I have a slightly different take on the November jobs number (203,000 jobs were created and the unemployment rate fell to a 5-year low of 7%). The non-farm payrolls was a Goldilocks (not too-hot, not-too-cold) number.

MORE: Can high-flying stocks keep soaring next year?

It was a good number but it was not so good as to scare the Fed or the bond market. It is possible that you could have a December taper (when the Fed meets Dec. 17-18). But it doesn’t really change the trajectory of monetary policy either in terms of the pace of the taper or in terms of short-term rates being low for long.

USA TODAY: Kevin, do you view tapering as tightening of monetary policy? And how do you think stocks will react to tapering once it begins?

Kevin Landis, CEO and portfolio manager, Firsthand Technology Value Fund: I guess the big fear is what happens when we all switch to decaf on the same day, right? And, looking out at the tech landscape it is not going to stop the trends that are already in place. But it could kind of throw a little bit of a wet blanket over the market and the macro picture.

Stimulus is always welcome when you need it and then you always cry when it is taken away. So, if it makes stocks cheaper for a little while, that is so much better for the rest of us. And rather than take a position on the debate, I think we will see what kind of opportunities it gives us.

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