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Bonds, Stocks, and Bernanke.

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Bonds, Stocks, and Bernanke.

Submitted by Foundation Private Wealth Management on June 28th, 2013

“Job gains, along with the strengthening housing market, have in turn contributed to increases in consumer confidence and supported household spending.”

Ben Bernanke, June 19th, 2013.

This is an excerpt from the recent statement from Ben Bernanke, the Chairman of the Federal Reserve Bank in the US. At the outset, this seems like a fairly positive statement to be hearing from Bernanke regarding the ongoing economic recovery in the United States, which is still the largest and most dominant economy in the world; however, would the markets agree?

Before discussing the net effect of Bernanke’s comments, along with our expectation on the longer term implication in the markets, I just want to take a moment to recap three major trends we have been watching closely within the US:

  1. The recovery will continue where the collapse occurred. We all remember 2008 and the havoc caused by the sharp decline in the US housing market (precipitated the banking system). Since then, the housing market has begun its recovery and, on the same day the above quote was made, US existing home sales crossed the 5 million mark exceeding expectations to a level not seen since the November 2009 tax credit. In addition to this, a number of other positive figures were released by the National Association of Realtors that continues to point to an improving recovery, which has also stimulated new homebuilding to meet consumer demand.
  2. Re-shoring of American jobs. In the past, we have discussed the renaissance in US manufacturing and this is a trend that is continuing. Some believe this is solely based on altruism and an underlying “Buy American” theme. According to Harry Moser, President of the Reshoring Initiative, this is not the case because “when companies actually sit down and take a hard look at the numbers, they often realize that they failed to take into account all the costs of doing business offshore." The full article, along with examples of a number of companies that have moved jobs back to the US, can be found here.
  3. Most importantly the resurgence of America as a top energy producer has never been as real as it is today. According to the International Energy Agency (IEA), the US will overtake Saudi Arabia and Russia as the top oil producer by 2017. For more on this, refer to the following article from Reuters. The implication that this has on the both the US and the global economy overall are profound on many levels. I also believe that this gives the US the chance, should their policy makers grab the proverbial bull by the horns, to deal with many of the fiscal issues they face now and in years to come.

Going back to Ben Bernanke’s statement, as anticipated, given the continued strength in the US economy he announced that the Federal Reserve would look to end the bond purchasing program they have been implementing (quantitative easing or QE). QE has kept interest rates low while simultaneously stimulating stock markets with cheap money. The announcement that the QE process would be slowing down caused a sharp increase in long term bond rates as seen below with the 10-year US treasury yield.

Source: Yahoo Finance as of June 24th 2013

It was inevitable that long term and even short term interest rates would rise eventually as they have been sitting at or near historic lows for quite some time. Many feared that a sharp increase in rates would cause a significant correction in the equity markets. The fact that the ‘tapering’ of QE is now happening in a managed way, with the Federal Reserve giving ample notice to the markets, is not a bad thing overall. In fact, it is a confirmation of the Federal Reserve’s belief that the economy is on a longer track to sustained reasonable growth and could ease the pain felt in the markets.

This news, however, is not overly optimistic for bonds, which could face some headwinds in the months to come if interest rates continue to rise. For this reason, we have diversified our fixed income portfolios to not be as sensitive to a rise in Western government bond yields and we continue to look for ways to diversify them further.

For equities, in particular US stocks, we continue to believe, based on the reasons I highlighted above, that they still provide an excellent opportunity for investors.

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