“Waiting for Godot”
Play by Samuel Beckett
In many ways the absurdist play written by Samuel Beckett is a metaphor for the current discussion of future Fed policy. Overanalyzed with endless hyperbole, the Fed’s winding down of QE3 will most likely qualify as a non-event at its implementation. Chairman Bernanke has given no specific exit plan, only that it is data dependent. Economists and market strategists, wrong on their forecasts over the past few years, blame the Fed, giving rise to the assumption that they are incapable of a smooth policy adjustment. While there may be a short-term fallout for equities, when initiated, the economy will be stronger and the unemployment rate will be lower. Longer-term investors will want more exposure to equities, providing the catalyst, along with moderately rising interest rates, for the “Great Rotation” discussed in last week’s report. In the play Godot never came.
Chances are by year-end the Fed policy for exiting QE3 will have begun. Despite the negatives voiced by market strategists of the tapering or suspension of bond purchases, stocks, as measured by the S&P 500, have risen over 14% since the beginning of the year, and are now 150% off the fiscal crisis bottom in March 2009. The economy is forecast to accelerate in the latter part of 2013. Housing will continue to drive GDP growth with improvements in sentiment as house prices tick upward, and jobs are opened in construction and ancillary businesses. A lessening of the fiscal drag will add to growth. Even today the Sequester has not slowed down the economy as erroneously predicted the Administration and, in fact, the deficit is now 5% of GDP, compared to 10% only a short while ago. Core inflation, currently rising 1.7% year-over-year, presents no impediment to policy implementation.
Rates will rise, but not to the levels forecast by the perma-bears. With any slowdown in emerging countries’ growth, funds will shift to the more stable US markets rather than Europe, providing a floor for US equities and an additional inflow into fixed-income. Most adversely affected will be ETF and mutual fund bond investors, who will not comprehend the decline in principal until their statements, as rates move higher. According to well-respected authorities in housing research, mortgage rates will have to rise above 5% to present a meaningful deterrent to the current recovery. More stringent requirements for mortgages have already removed those borrowers affected by moderately rising rates.
Our investment strategy remains a full position in equities. The increased volatility is indicative of market uncertainty, not of a chaotic outcome of Fed policy. However, the run-up since the beginning of the year for equities and the recent rise in interest rates makes the possibility of a correction more likely. Longer term earnings growth should accelerate later in the year as private economy growth accelerates and the next leg of the bull market rises to new all-time highs and a return to the “Old Normal.”
David Minor Rebecca Goyette