In a surprise move last week, the U.S. Federal Reserve did what investors had been anticipating for months. The Fed announced that in January it would scale back its monthly bond purchase program to $75 billion from $85 billion. In sharp contrast to early fears that the Fed would remove support too quickly, investors responded with enthusiasm seeing the move as a sign of confidence that the economic recovery is in fact progressing at a decent pace.
What was more meaningful than the Fed’s actions was the wording by Chairman Bernanke in his last statement. The “forward guidance” suggested that they will monitor the situation closely and will be prepared to accelerate purchases if need be. Janet Yellen’s involvement in this process will be crucial as well. The main takeaway for these comments is that interest rates are likely to stay flat well into 2015.
So what concerns us? While the markets were in rally mode last week, we began to review what circumstances could cause a change in sentiment that might alter our view of the markets. There has not been a correction of more than 5% since June and there are several factors we are watching that may prompt a near term correction.
1) Debt Ceiling Discussions
The debt ceiling issue must be addressed again by February 7. While the government shutdown in October only caused a mild pullback, we are watching closely to see how this will be resolved. A divisive political environment has the ability to send a shock to the market as the market hates uncertainty.
2) Fourth Quarter Earnings
Earnings reports for the S&P 500 will start again in early January. With U.S. GDP expected to be somewhere around 2.5% to 3% in 2014, growth will be central in driving top line earnings. Many S&P 500 companies have been hitting their quarterly earnings by cutting costs; the market would like to see better top line sales.
3) Election Cycle
As we enter the mid-term year of the Presidential election cycle, we are up against historical challenges. According to the NDR monetary fiscal policy index, over the last 50 years, this has been the most challenging year of the four years. Our expectation is that we will see more volatility than in 2013.
4) The Taper Effect or the 10-year Treasury
The taper will mean less demand for Treasuries which will affect pricing. Many Wall Street economists expect the 10-year to be over 3.5% by late 2014. This sharp move in yield could be disruptive if it does not occur gradually. Significant moves in the 10-year yield could prove challenging for the bond market and mortgage rates.
Our team remains modestly confident that 2014 will be another decent year for stocks. We feel the Fed will orchestrate the taper in a thoughtful manner and that the impact in the economic data is real. We are however watching these four issues carefully and will be proactive in making any needed adjustments to your investment strategy.
Best wishes from our entire team for a Healthy & Merry Christmas.
Please join us for our open house on January 9th
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