The Fed Makes its Mark

On Wednesday June 19th, following a regular Federal Reserve Board (Fed) meeting, Chairman Ben Bernanke made an announcement composed essentially of two parts. Mr. Bernanke said the Fed would wind down the bond-buying program, in which they have been buying $85 billion in bonds monthly, and work towards a goal of ceasing the operation by mid-2014. His justification for the change is an optimistic assessment of the current state of the economy and its direction over the next two years. The Fed expects the jobless rate, which was 7.6% in May, to fall to 6.5% to 6.9% by the end of 2014. Mr. Bernanke commented on better fundamentals, saying, “In particular, the housing sector, which has been a drag on growth since the crisis, is now obviously a support to growth.” He was referring to rising home prices increasing household wealth and thereby strengthening consumer confidence and spending. Overall, the Fed expects the economy to grow by 3.0% to 3.5% in 2014, which would be a marked improvement. The Fed also expects inflation to remain low, between 1.5% and 2%. Other members of the Fed indicated that it is unlikely the Fed will begin pushing up short-term interest rates until 2015. Better economic growth, low short-term interest rates and a housing boom all seem very positive. The problem is, many in the financial community believe the result of the Fed reducing, then eliminating the bond program will bring higher mortgage interest rates, a slowdown in housing, reduced consumer confidence and a stalling of the economy. Fear of what might happen when Mr. Bernanke steps down in January of 2014 is an additional negative. Markets don’t like uncertainty!
The bond and stock markets’ response to this change was sudden and sharp! The value of bonds and the value of stocks both dropped. As interest rates on a bond rise, the value of the bond drops. A month ago, for example, the 10-year Treasury bond had about a 1.7% interest rate. Now, the rate is 2.59%, or a drop in value of about 8%. The stock market has also taken a big hit with the S&P 500 down 5.7% since May 28th, falling from 1661 to 1566. Gold, too, has fallen. The day of Bernanke’s announcement, the value of an ounce of gold was $1,373.60 and is now $1,276.90, a drop of over 7% in a matter of days. So much for the safety of gold. For the investor, this may be a good time to take a summer respite and come back in the fall. The next few months could show substantial market volatility. If Mr. Bernanke and the Fed are correct, we should see the economy continue to pick up as we move forward in 2013. That being the case, the stock market should recover, eventually, and the bond market will settle down. For now, we will wait and see.
Ed Mallon
(written Monday, June 24, 2013)

Mixed Market

When putting together an investment portfolio, you do not want your various investments to move up or down in tandem all the time. That is why one of the basic tenets in building a portfolio is to use non-correlated assets. Two broad categories of non-correlated assets are stocks and bonds. Stocks move separately from bonds and for this reason we like to have both in a portfolio. The current environment might appear to contradict this non-correlation of stocks and bonds, since both have lost value since May 9th. In fact, this does not disprove non-correlation; it just proves that current information has pushed both stocks and bonds downward. The question, therefore, must be “Why?” Looking at the bond market, we know that as interest rates rise, the value of bonds decreases. Lately, interest rates have begun to rise, in large part due to the uncertainty of the Federal Reserve Board (FRB) policy on buying $85 billion of bonds monthly, which has kept rates low until recently. The stock market moved down, reflecting the fear that a reduction in buying by the FRB would stall the economy, just as it was beginning to pick up momentum. My belief is that the FRB decided to test the markets by seeing what would happen if a reduction in buying bonds was to begin shortly (this summer or fall). The result has likely been to make them very concerned about such a possible change. The FRB meets next Tuesday and Wednesday, and will be discussing this issue and what they need to do. As the fears of reduction of bond purchases by the FRB have grown, the currencies of Japan and Europe have risen, which, if continued, would curtail any chance of growth for them. Emerging countries are seeing the value of their currencies decreasing, as investors avoid risk in favor of liquidity, creating a negative impact on their economies. The impact of a possible change in bond purchases by the FRB has already resulted in the bond, stock and currency markets preparing for the worst. It is my belief that the FRB is well aware of their role in leading the world out of an economic recession. With what has taken place in a very short period of time, the fragile recovery is headed in the wrong direction. For three years now, the FRB has been working to create momentum in the economy. I don’t think they are going to do anything to disrupt the goal at this time. Everyone wants to know, “What’s the deal?” The FRB must come out next week and say, with a great deal of certainty, that there will be no change in our buying of $85 billion each month until early next year at the earliest, or some similar indicator of their plans! A week from today we should have a pretty good idea of what they will be doing and for how long. If not, markets will continue to be volatile.
Ed Mallon

In the Name of National Security

How far should the federal government be allowed to go in reducing freedom and privacy to provide security for our nation? Since 9/11, the federal government, in the name of national security, has not only reduced certain freedoms and collected more data, but has also authorized holding assets and individuals without their normal rights under the Constitution. This secretive use of power has been building up for some time. With the NSA document leaks, reported in the Guardian newspaper last week, the massive level of surveillance over the public was revealed. This time we were made aware of how invasive the government is willing to be to “protect our rights.” Clearly, the genie is out of the bottle, recognizing that large volumes of data can be mined easily to find specific information. The time has come to take the shroud off the NSA and make them as accountable to the public as any other government agency. When we allow our government to keep secrets from our own citizens, it does not turn out well. An open discussion and evaluation is needed to decide the boundaries for information gathering on our own citizens before we lose this hard won democracy that we all cherish.
Ed Mallon