The Federal Reserve’s recent actions continue to show that the Fed is unwilling to accept anything other than above-trend economic growth and higher inflation. Back in November of 2010, the Federal Reserve reiterated its pledge to keep interest rates low for an extended period and they also announced plans to buy $600 billion in U.S. Treasuries in a round of unconventional monetary stimulus known as quantitative easing. You may have heard this latest move by the Fed described to as “QEII,” so named because this latest round follows an earlier round of treasury purchases started in March of 2009 known as “QEI.” The old Wall Street saying, “Don’t fight the Fed” comes to mind when reviewing the Fed’s current policy. The old adage recommends that investors should decrease equity exposure when the Fed is raising rates and increase equity exposure when the Fed is cutting rates. This appears to be the case today.
Whether you agree with the Fed’s policy or not it is important to understand what this might mean for your investments. The Fed is stepping on the gas pedal and providing ample liquidity to underpin the economy. This could continue to be a bullish indicator for all types of “risk” assets like stocks, commodities, and corporate bonds. Keeping rates very low should also have the effect of devaluing our currency. This can give an additional boost to commodity prices and pump up the returns in international stocks and bond holdings. In my opinion, the Fed is basically telling us that interest rates are going to remain low for some time so holding cash is going to continue to be a very low returning strategy. The Fed wants the stock market to go up, they want to stimulate economic growth and risk taking.
Our economy remains in a fragile state but conditions continue to look less bad. The U.S. economy is recovering but at a very slow pace. I certainly do not expect things to start booming again. Far from it. Unemployment is expected to remain high and the housing market is still years away from recovery. However, this backdrop is not necessarily bad for stocks. Low interest rates, low inflation, low expectations and an accommodative monetary policy could create a favorable backdrop for higher equity prices.
In this environment I favor stocks over bonds. I expect both U.S. and emerging market stocks to do well. I also believe commodities and commodity oriented stocks are attractive. Within your bond allocation I would consider corporate bonds over government bonds and also like international and emerging market bonds. Get invested, stay invested, diversify and don’t fight the Fed. Happy New Year to each of you!
Damien helps individuals invest and manage risk. He is a CERTIFIED FINANCIAL PLANNER™ professional and a principal of Walnut Creek Wealth Management. These are the views of Damien Couture, CFP® and should not be construed as investment advice. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Your comments are welcome. Damien can be reached at 925-280-1800 x101 or Damien@WalnutCreekWealth.com.
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