By John Whitefoot for Daily Gains Letter
Normally, this kind of news would help shore up the stock market and send it rallying higher. But that’s not what happens in a Federal Reserve-fuelled market; in fact, the Dow Jones Industrial Average, S&P 500, and NASDAQ all responded with a losing streak.
Why the fear? Two words: quantitative easing. Since implementing the first round of quantitative easing in 2009, the Federal Reserve has flooded the market with over $3.0 trillion. Quantitative easing has translated into artificially low interest rates. The low-interest-rate environment has also been the primary fuel behind the stock markets’ unprecedented rally.
The Federal Reserve has said it will begin to taper (not discontinue) its quantitative easing strategy when the markets improve, which many believe means an unemployment rate of 6.5% and inflation at 2.5%.
Not surprisingly, the sharp decrease in unemployment has made the markets jittery. Tapering quantitative easing bond purchases means interest rates will increase, which could put a wet blanket on the U.S. economy. Back in May, the Federal Reserve hinted it was thinking about tapering quantitative easing; Wall Street responded by sending the markets lower, and banks responded by sending mortgage rates higher.
So you can see why an irrational Wall Street would be stressed about an improving economy and a pullback in quantitative easing. The markets would have to stand on their own merits—namely, revenue and earnings. That’s something it isn’t ready to do just yet.
They may not have to for a while yet, as the numbers needed to trigger a pullback on quantitative easing still aren’t firmly in place. Two Cleveland Federal Reserve researchers do not think the unemployment rate will get to 6.5% until the first quarter of 2015 at the earliest, but most likely no later than the third quarter of 2015. The inflation rate, meanwhile, may not break through 1.75% until 2016. (Source: Knotek II, E.S. and Zaman, S., “When Might the Federal Funds Rate Lift Off?” Federal Reserve Bank of Cleveland web site, December 4, 2013.)
But, as the old saying goes, “buy on rumor, sell on news.” However, the losing streak won’t last for long.
Since hitting a low in March 2009, the S&P 500 has soared almost 165% and is up 26% so far this year. Since hitting a pre-recession high in mid-October 2007, the S&P 500 has climbed 16%.
As long as the Federal Reserve continues its quantitative easing policy—or rather, keeps interest rates artificially low—the markets will continue to be bullish, and any losing streak will have a limited downside.
After all, where else can investors go with their money? Thanks to short-term interest rates being near zero, it doesn’t make sense for investors to park their money in bonds or leave it in cash.
When it comes to a jittery market, it’s always a good idea to hold financially solid stocks with a long history of providing not just capital appreciation and dividends, but also increased payouts; some examples of this type of stock may be Cathay General Bancorp (NASDAQ/CATY) and Oxford Lane Capital Corp. (NASDAQ/OXLC).
Despite all the good economic news, quantitative easing will stick around and the markets will continue to advance—and Wall Street will get it right for the wrong reason.