The Cornerstone

June 2013

“The end of QE?”

Wow! What a week! In a press conference following this week’s FOMC meeting, Fed Chairman Ben Bernanke provided markets with a clearer understanding on how the Fed expects to phase out its current quantitative easing (QE) program. This timetable is justified both by economic progress and by the significant future costs which a too-large Fed balance sheet is likely to entail. Moreover, the timetable, while never previously explicitly outlined, should not have been a surprise to most market observers. Nevertheless, Mr. Bernanke’s words have been met by a sharp selloff across a wide range of financial assets. For investors, it is important to distinguish between logical market reactions and over-reactions while still positioning portfolios for an environment of rising interest rates. It needs to be said that a timetable for ending QE is far easier to justify than the program itself. The current QE program combined with a near-zero federal funds rate amounts to the most extreme dose of monetary stimulus applied by the Federal Reserve in its 100-year history. With the economy in its fifth year of recovery, unemployment down 2.4% from its peak, home prices and stock prices up sharply over the past year and financial stress clearly much lower than a few years ago, it is hard to justify such an extreme approach. It is also unlikely that this monetary ease is really helping growth. In fact, by reducing the income of savers, discouraging lending by artificially lowering long-term rates and convincing people that they don’t need to borrow ahead of higher rates, recent monetary policy may have been more of a drag than a boost. The bottom line is this: the longer the Fed goes down this road, the greater the chance it can lead to inflation, slower growth or a possible spike in interest rates – or all three together. Since the announcement most markets have gone down, some justified and some not.  Fixed income (bonds, notes, etc.) selling is not a surprise, it is in line with my expectations, and I think is still in danger of more losses.  The stock market sell-off seems extreme with the S&P losing twice as much as the 10 year bond. Consider that Bernanke has actually lessened uncertainty by showing us his path. It is data dependent and the QE program combined with low interest rates will stay around as long as is necessary.  My own opinion about their comments is more positive than the stock market showed us. The housing market is in a firm recovery and, even with somewhat higher mortgage rates, overall housing affordability will remain far better than in recent decades. There is little likelihood of further significant federal tightening over the next few years while state and local government employment is now beginning to rise. Most importantly, a move toward more normal interest rates should help convince many businesses and consumers alike that the economic crisis is over and reduce the hesitancy to act which is always the most pernicious aspect of a weak economy. This should become clear soon and equity markets should reflect this. In the meantime, it is important for investors to continue to position their portfolios for rising interest rates, with a tilt towards growth. Welcome to Summer – and as always – Thank You Very Much for Your Business!        Phil   The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice.  We suggest that you discuss your specific tax issues with a qualified tax advisor. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  “Stock investing involves risk including loss of principal.  The Dow Jones Industrial Average is an unmanaged index and cannot be invested into directly.  Past performance is no guarantee of future results.”  References:  LPL Weekly Market Commentary dated June 24, 2013.  The economic forecasts set forth in this commentary may not develop as predicted and there can be no guarantee that strategies promoted will be successful.