The Federal Reserve made it official on Wednesday, announcing it would be cutting the remaining $15.0 billion from its monthly bond-buying program, also known as QE3.
So with that, the period of easy money flowing into the pockets of investors is over. Remember, it was the Federal Reserve’s relaxed easy monetary policy that helped to drive the S&P 500 up nearly 200% since 2009—and now it’s over, folks.
The stock market reacted with stocks heading lower, as there was a slight sliver of hope the Federal Reserve would decide to hold back on eliminating QE3. Investors will now have to deal with bond yields that could begin to move higher on the Federal Reserve’s move.
The Federal Reserve didn’t give a timeframe for when interest rates will begin to move higher from their near-zero levels, but the consensus is calling for the rate increase to begin sometime in mid- to late 2015. As you know, higher rates by the Federal Reserve will drive up yields and carrying costs for both companies and personal debt. Just think about the more than $17.7 trillion in national debt and how the higher interest rates will impact the government’s out-of-control carrying costs.
We are at what I would call a crux.
Stocks want to go higher but need a fresh catalyst to do so. The advance reading of the third-quarter gross domestic product (GDP) growth came in at a healthy annualized growth rate of 3.5%, which while down from the booming 4.6% in the second quarter, is nonetheless indicative that the economy is expanding.
At the end of the day, a strong economy, continued … Read More
The stock market appears anxious to move higher to new record highs.
In the past week, the Federal Reserve released its Federal Open Market Committee (FOMC) meeting minutes that suggested it wanted to see stronger, sustained growth before deciding on when to raise interest rates. This includes both economic growth and jobs creation.
On Thursday, the Bureau of Economic Analysis (BEA) will report the second reading of the second-quarter gross domestic product (GDP), which came in at a surprising annualized four percent for the advance reading.
The consensus is that the second reading will show the GDP growth holding at the same four-percent level. If it does, it would be excellent for the economy but at the same time, ironically, it would make investors and the stock market nervous about the status of interest rates.
The issue is that the Fed wants to see controlled and steady economic growth and a four-percent reading could raise red flags, pointing to inflation—which means higher interest rates. The inflation rate is benign at this time as consumers continue to hold back on spending.
The stock market will get anxious if the reading remains the same, but we would want to wait to see how the economy fares in the third and fourth quarters of the year before making any drastic moves.
Of course, the stock market is all about expectations going forward and clearly, a strong second reading of the 2Q14 GDP will send some to the exits.
The Fed also wants to see the jobs market continue to expand at its previous trend of generating an average of more than 200,000 monthly … Read More
While I continue to favor the stock market as the top investment vehicle long-term, I am concerned about the pending rise in interest rates and bond yields; of course, higher bond yields translate into a viable option for investors to stash their capital aside from the stock market.
The Federal Reserve has begun the process that will reduce the easy money it has been injecting into the stock market and economy. So far, $30.0 billion in bond purchases each month has been cut, and I expect the remaining $55.0 billion to be eliminated by the year-end.
The end result will be a steady rise in bond yields along the way, which will cause some rotation of capital from the equities market to bonds. We have already seen a big jump in the 10-year bond yield, from about 1.7% in May 2013 to 2.8% as of April 2014. The yields will continue to rise as the Fed reduces its quantitative easing over the year. A move to above the three-percent threshold level will clearly trigger some anxiety among stock investors
The consensus on the Street is for bond yields to rise. The recent auction of $29.0 billion of seven-year notes by the U.S. Department of the Treasury last Thursday yielded 7.317%.
Simply look at the chart below of the 10-Year US Treasury Yield Index from 1990 to 2014.
Chart courtesy of www.StockCharts.com
The first thing you should notice is the rising yields. The chart from 2012 onward reflects the rise in interest rates measured by the bellwether 10-year U.S. Treasury that is surging higher. The yields on U.S. Treasuries have almost … Read More
The stock market staged a minor rally last week, but don’t get too excited yet; the buying support was largely triggered by a technically oversold market, rather than solid fundamentals or a fresh catalyst.
What I can say is that investors need to be careful with the high-beta stocks that are extremely volatile at this time and vulnerable to downside selling.
Just because momentum surfaces, it doesn’t mean the risk is dissipating. It’s simply an oversold bounce that could continue or falter again.
The fact that the Dow Jones Industrial Average and S&P 500 recovered their 50-day moving averages (MAs) last Tuesday is positive, but it doesn’t mean the worst is over.
I see the NASDAQ and Russell 2000 were still down more than seven percent as of last Wednesday and below their respective 50-day MAs. In fact, the Russell 2000 is within reach of testing support at its 200-day MA. This time around, we could see a bigger stock market correction, based on my technical analysis.
Until we see some sustained calm return, there could be continued selling pressure in the stock market, especially with the smaller high-beta stocks and large-cap momentum plays.
The most critical point to understand is that you need to preserve your capital base. The reality is that avoiding a loss is just as good as making profits. Imagine letting a losing trade run and before you realize it, the position is down 20%, 30%, or more.
This is especially true with the small-cap stocks. Making up ground following a major downside move is not easy. For instance, say you have a $10.00 stock and … Read More
The verdict is in…
The Federal Reserve will taper further. In its statement, the Federal Reserve said, “Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month.” (Source: Board of Governors of the Federal Reserve System web site, March 19, 2014.) The Federal Reserve has been tapering quantitative easing since January by $10.0 billion each month, coming down from $85.0 billion a month in December.
To us, it will not to be a surprise to see the Federal Reserve taper further. If this becomes the case, then in just five months, there will be no quantitative easing. The printing presses will stop.
This doesn’t bother me. It’s all too known and expected.
With this taper announcement, the central bank also provided its projections on where the federal funds rate—the rate at which the Federal Reserve lends to the banks—will go. It said the rate can increase to one percent by 2015. By 2016, this rate can go up to two percent. Mind you, the federal funds rate has been sitting at 0.25% for some time now—since the U.S. economy was in the midst of the financial crisis.
What happens next?
Economics 101 tells us that when interest rates increase, bond prices decline and bond yields increase.
Quantitative easing and low interest rates have caused more harm than good. These two phenomena caused the bond prices to rise and … Read More
An interesting conversation on investments surfaced recently at a dinner party with some friends. The topic was whether it was better to buy large-cap dividend-paying stocks, such as General Electric Company (NYSE/GE) and The Procter & Gamble Company (NYSE/PG), or look at smaller dividend-paying companies.
Of course, I spontaneously said it depended on a host of factors, including the risk appetite of the investor and the economy.
When the economy is growing, and especially as it emerges from a recession like we saw it 2008, it would be advantageous to stock up with smaller dividend-paying companies. The reason is because small companies tend to fare better when adjusting out of a slow period than larger companies, which take much more time to strategize and put a plan into effect.
Another way of looking at it is that it’s easier to steer a smaller boat versus a larger ship in calm waters, but when it gets rough out there, I would rather stay on a bigger ship. The same analogy applies to the question of small-cap versus big-cap stocks.
Now, as far as dividends are concerned, the most important thing is the underlying strength of the company and its previous and forward ability to pay dividends. You want to buy dividend-paying companies that have a valid and sustainable business—no fad stocks here.
Another major monetary benefit of small dividend-paying stocks is the much superior upside price appreciation potential that’s often associated with small-cap stocks. So while companies like General Electric and Procter & Gamble will consistently do well over decades, in the short run, adding some small dividend-paying stocks can help … Read More
While the S&P 500 continues to perform well, the markets have been skittish since May 22, when the Federal Reserve hinted it might consider tapering its $85.0-billion-per-month bond-buying program. If Ben Bernanke begins to curtail Wall Street’s monthly allowance, there are fears the markets will not be able to stand on their own economic merit.
Granted, many don’t think the Fed will begin tapering in 2013; this may account for the S&P 500’s solid, yet volatile run. The same can’t be said for emerging markets.
Investors have pulled over $22.0 billion from emerging-market bond funds since the end of April. This has lifted emerging-market bond yields by 1.4 percentage points, almost the most in five years.
Borrowing costs have been on the rise from record lows as speculation swirls around when the Federal Reserve will begin to cut back its quantitative easing measures—this also means the end of artificially low interest rates. This matters to emerging markets, because it signals the end of cheap money that’s been propping up asset prices in countries like India, China, and Indonesia.
Those investors who diversified their retirement fund with emerging-market exchange-traded funds (ETFs) have been in for a rough ride. The MSCI Emerging Markets Index (NYSE/EEM) is down eight percent year-to-date.
One of the few places where the Federal Reserve’s sphere of quantitative easing influence is muted is in the world of frontier markets. Frontier markets refer to countries such as Argentina, Kenya, Qatar, and Vietnam—those markets that are in the early stages of development. Frontier markets are an attractive opportunity for investors, because they represent a long-term economic growth possibility. And there … Read More
With the Federal Reserve signaling its $85.0 billion-per-month quantitative easing policy may be coming to an end, many investors are scrambling, looking for places to invest.
The Fed cutting back on its monthly Treasury bond and mortgage-backed security purchases means demand will slide. And that will take the price of bonds with it, sending yields and interest rates higher.
The easy money may be coming to an end, but that doesn’t mean there aren’t safe havens out there for investors to take advantage of. All you need to do is find those equities that do well when interest rates rise.
Many investors believe that rising interest rates are a boon to the banking industry. But if short-term interest rates get too high, individuals with huge debt loads often end up defaulting—and that costs banks money.
Banks tend to make money when long-term rates rise faster than short-term rates. In that scenario, banks can borrow more cheaply from depositors and make more money from higher-interest loans.
It may not be as glamorous as investing in gold, platinum, or oil and gas, but one sector that looks like it could benefit from higher interest rates is life insurance. While the markets have been tanking on fears of stimulus easing, some insurance stocks have been surging.
That’s because bond yields are to life insurance companies what metal prices are to the mining industry. As a result, insurance companies are the one industry that actually thrives in an environment of rising interest rates.
That’s because insurance companies make money on the returns they earn on premiums from policyholders. Insurance companies don’t make as much … Read More
Starting near the end of 2012 and then going into 2013, there was a significant amount of noise around the concept of the “Great Rotation.”
The idea behind this concept is that low yields on U.S. bonds would cause investors to sell their bonds positions, which would eventually bring bond prices down, driving investors toward stocks. That would send the key stock indices higher.
Now, since the Federal Reserve announced that it might be pulling back on its quantitative easing, the concept of the Great Rotation seems to be gaining some traction once again. And investors are asking if it’s really going to happen.
Looking at the chart below of 10-year U.S. bond yields, it’s very clear that investors don’t like the U.S. bonds—they are selling. The yields on 10-year U.S. bonds have skyrocketed; they are now more than 44% higher than they were at their lowest level in August 2012.
Chart courtesy of www.StockCharts.com
According to TrimTabs, an investment research company, through to June 24, investors sold $61.7 billion worth of bond mutual funds and exchange-traded funds (ETFs). While this may not sound big, this is the highest sell-off since October 2008, when investors sold $41.8 billion worth of mutual funds and ETFs. (Source: Bhaktavatsalam, S.V., “U.S. Bond Funds Have Record $61.7 Billion in Redemptions,” Bloomberg, June 26, 2013.)
Now that we see investors fleeing the bonds market, shouldn’t they go to the stock market, thereby causing the markets to climb higher?
Yes, according to the concept of the Great Rotation, the key stock indices should be climbing higher. Sadly, the reality is the opposite: as the bond prices … Read More