The tipping point for markets this summer was undoubtedly Ben Bernanke’s press conference on June 19 after the latest FOMC meeting when he sought to clarify the Fed’s goals. It wasn’t so much what he said, but what everyone thought they heard, that caused turmoil in markets, as traders jumped to the conclusion that quantitative easing was ending sooner than expected. What he actually said was that, depending on a substantial improvement in the labor market and, as long as inflation remains quiescent, the Fed could start reducing the pace of its bond buying program later this year. When the economy is healthy enough, maybe by next summer, quantitative easing programs could be ended, reducing the stimulus by not tightening.

It didn’t take long for markets to react to the Fed’s message. Bond prices sold off with yields on Treasuries and all other bonds rising sharply. The dollar rose, presumably attracting funds from other riskier parts of the world, and after a brief dip, the stock market recovered to a new all-time high. Yields had been low based on a consensus expectation that the economy would be weak for a long time and that the Fed would keep short-term rates low. Unconventional monetary policy began when QE1 was announced in 2008 at the time of the financial crisis and has been expanded five times over the last 5 years. The Fed’s current asset purchase program was put in place last December to help offset the impact of the fiscal drag.

There is a lot of debate going on about when the tapering of the monthly $85 billion asset purchase program should begin, but whenever the tapering comes, it will be gradual, not abrupt. The zero interest rate policy has been in place since 2008 and it is not likely that there will be any increase in the Fed funds rate for a long time. In a speech last week Bernanke said, “You can only conclude that a highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy”.

Equities: Interest rates will naturally move higher as the economy grows and higher interest rates are to be welcomed, not feared. The U.S. economy is growing, earnings are rising, and equities are attractive on valuations. As John Templeton said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria”. While stock prices are now fully recovered from the 2008-9 bear market, many remain skeptical, and stocks continue to be an attractive asset class for most investors.



Fixed Income: Historically, an investment in bonds provided a way for more conservative investors to generate higher income flows and help reduce exposure to the volatility in prices of equities and other asset classes. However, with interest rates still at extremely low levels bonds have a greater exposure to principal price risk when interest rates rise and won’t meet these goals. Therefore, where bonds would normally be included to meet specific client objectives, investors today should include more flexible fixed income strategies for this portion of a portfolio.

One example is floating rate mutual funds: These hold bank loans which are collateralized and are senior in a company’s capital structure. They have appeal during a period of rising interest rates since the rates on the underlying bank loans are reset every thirty to ninety days and, therefore, provide income and principal protection when interest rates rise.


Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.