Selling the Rumor and Buying the News on the Fed

by Bryan Perry | December 17, 2013 8:00 am

On deck for Wednesday is the Fed’s last FOMC meeting of 2013. That event is about as anticipated as a three-year-old waiting for Santa to show up on Christmas Eve as the investing world prepares to digest the level of forthcoming tapering of QE. Leading up to the Fed gathering, markets have retrenched following a string of firmly improved economic data points that raise the notion of sooner-than-later Fed action.

Interestingly, the bond market has been behaving quite well, absorbing all the taper talk as if it understands the Fed’s intention of unwinding in baby steps more confidently than the equity markets, where volatility has jumped in the past couple of weeks. The rate of inflation, or lack thereof, might have something to do with the firmness in bond prices. Data for producer prices, CPI, unit labor costs and input costs have all come in flat for the past month while ISM, GDP, auto sales, home sales and employment data showed strong gains, implying higher profit margins for manufacturers.

I’ll go out on a limb and maintain my position that the Fed won’t taper until March, depending on the economy. As Wells Fargo (WFC[1]) analyst John Silvia recently noted, one challenge that the U.S. central bank will face is how to square its so-called “data dependency” with inflation that’s running below its 2% target. Prices are accelerating at a 0.7% annual rate, the personal consumption expenditures price index showed in October.

The yield on the benchmark 10-year Treasury note is holding well at 2.85%. Crude oil has rebounded from $92 to $97.29 per barrel even as headlines cross the tape that Iran and Libya are coming back on line to export oil. Natural gas is holding its breakout move higher at $4.27/MMBtu, which is sparking a fresh round of bullishness for this clean-burning and abundant fuel that has been a mega theme of Cash Machine and remains so.

As the market digested the November gains, the backing-and-filling process showed the S&P 500 receding only about 40 points (or about 2.2%) from its 52-week high of 1,813 and successfully testing and holding its 50-day moving average at 1,770.

Much of the selling in specific sectors isn’t rational, but that’s the market’s persona from time to time: irrational and illogical. I can’t fix that, but I can encourage folks to think beyond short-term gyrations and stay focused on the larger themes at work. Unlike those investors relying on straight Treasuries, municipal bonds, long-dated corporate bonds, fixed-rate government agencies (like Fannies, Freddies and Ginnies), preferred stocks and fixed-rate mortgage REITs, who truly have high risk exposure if interest rates suddenly hike up, I’ve positioned our model portfolio to not just withstand an up-rate market, but to benefit from it over the course of time.

With Monday’s rally based more on improving data out of Europe, the market is finally sending a message to the Fed of “bring it on” — gradual tapering is not going to be materially disruptive. Again, I think the Fed will opt to err on the side of overshooting QE and juice the economic goose with an extra measure of liquidity. That way, investors will ride the momentum into 2014 with a higher level of certainty as to how the stock market will ultimately react. The Fed can always accelerate the unwinding if necessary.

 What hasn’t changed is the rising trend of retirees in a market that offers little in the way of conventional investment yields, currently running about 0.25% for money markets to 5.4% for shares of AT&T (T[2]). As long as that investing backdrop persists for those depending on income, my high-yield themes of lending to small business, floating-rate debt, convertible debt, health care hybrid income, energy income, asset-management-based income, covered-call equity-based income and transportation-based income should continue to draw a growing crowd of investors in the year ahead.

  1. WFC:
  2. T:

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