Question: Does good economic news hurt financial markets?
Answer: It certainly looked that way during May and June. In response to positive housing market reports and improved unemployment numbers, Federal Reserve Chairman Ben Bernanke suggested that the economy might be showing signs of strengthening. This positive news is a reason for the Fed to review its current monetary policy of extraordinary liquidity activity (which consists of pumping $85 billion into the economy each month). Assuming recovery continues, the Fed may begin to consider removing the “training wheels” and reduce or slow the economic support it has provided over the last couple of years. Markets responded with anxiety, fear, and volatility.
Former Federal Reserve Chairman William McChesney Martin stated that the Federal Reserve’s job is to take away the punch bowl just as the party is getting good. So yes, good economic news may temporarily have an unpleasant effect on markets. Here’s why: The Fed began purchasing mortgage-backed securities in November of 2008 to provide liquidity to the economy. This “easy money” policy stimulated economic activity. Now that the economy is showing signs of improvement, financial markets dread the prospect of slower Fed activity.
Bernanke only hinted that The Fed might cut back on the quantitative easing (QE) policies.
Low interest rates and liquidity are favorable for businesses buying equipment or consumers purchasing homes, so the discussion of higher rates causes anxiety and concern over an economic slowdown. That’s the paradox; good news causes concern that the Fed will take off the monetary training wheels obliging the economy to operate on its own merits.
We’ve seen this movie before. In 2010 the Fed halted bond purchases in response to what appeared to be an improving economy only to renew them a few months later. This proves that the Fed is somewhat reasonable and will leave itself plenty of room to maintain support if economic conditions don’t continue to improve.
Fed Chairman Bernanke’s task is to steer us through inclement economic conditions by applying appropriate pressure to the gas pedal. His challenge is to avoid stalling the economy or spinning
it out of control. At this point, it appears that Bernanke isn’t reversing course or slamming on the brakes, but merely thinking about easing off the gas pedal.
Overreaction to situations may cause indiscriminate sell-offs which often lead to dislocation and mispricing of markets. When fear and greed rule, rationale decision making and adherence to a disciplined plan may be helpful. An investment policy statement (IPS) is such a plan. An IPS provides guidelines designed to position your investments so they coincide with your aspirations.
Matching goals and outcomes is vital in all areas of life. When I started scuba diving, I was given a great piece of advice; “plan your dive and dive your plan.” Before entering the water there is an unwavering plan in place. We’re prepared and able to adapt to changing currents, unexpected storms, low visibility, and even an occasional distraction like a turtle that tempts to draw us off course. Evaluation of external conditions and the ability to adapt are necessary. Maintaining an adequate air supply for the entire trip is one of the most important elements for successful diving. This means planning for both emergencies and opportunities by keeping a reserve on hand. The same holds true for investors.
Monetary policy from the Fed tends to have broad based impact that can make it more challenging to protect your portfolio through diversification. It may be worth exploring how various asset classes in your portfolio could be affected by possible future Fed actions. Volatility also may present buying opportunities.
It’s important to maintain perspective in the face of market turbulence. While you should monitor the situation, don’t let twists or turns derail carefully constructed investments. Plan your dive and dive your plan. Stay focused and invest accordingly.
This information is general in nature, it is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or solicitation to buy or sell any particular investment. Investing involves risk and the possible loss of principal. Past performance is not indicative of future results. Diversification alone cannot guarantee a profit or protect against a potential loss. Opinions expressed herein are those of the author and subject to change at any time.
“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame design) in the U.S.”
Darcie Guerin, CFP®, is Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email email@example.com. www.raymondjames.com/Darcie