Global CIO Commentary by Scott Minerd
Maybe now the Fed Frenzy can end. After months of market jitters about when the Federal Reserve would start tapering quantitative easing, we now know the central bank will trim its asset purchases by $10 billion monthly, starting in January. As I wrote previously, whether the Fed tapered now or in a few months would make little difference to the big economic picture. The change of Fed policy, the swan song for outgoing Chairman Ben Bernanke, is based on the belief that the U.S. economy’s expansion is sustainable and that the labor market is improving amid muted inflationary pressures. The Fed’s statement after its two-day meeting was exceptionally dovish.
Incoming Chair Janet Yellen has made it clear that the Fed’s primary policy tool in 2014 will be forward guidance, or signaling clearly to markets how it plans to act in response to economic variables. Crucially, the Fed said it will keep interest rates near the zero-bound well past the time it takes for unemployment to fall below its previous threshold of 6.5 percent. In addition, the Fed has added a 2 percent lower bound for inflation, below which it is unlikely to begin raising the federal funds target rate. Both the employment language and the interest rate focus push out the time frame for a rate increase longer than investors had previously expected.
As markets consider the roadmap to exit the unprecedented policies of the Bernanke era, it is worth remembering that in addition to prolonged, low interest rates there is plenty of Fed stimulus left. If the Fed continues the same pace of asset purchase reductions at each FOMC meeting, it will still purchase more than $500 billion of bonds before QE would end in early 2015. It may purchase a greater amount, or prolong quantitative easing, if the economic recovery is more jagged. To put that in context, the Fed’s second round of quantitative easing, from November 2010 to June 2011, amounted to $600 billion.
So, Fed-driven liquidity and improving corporate profit margins, spurred by a strengthening economy, should continue nudging asset prices, especially stocks, higher. Still, long-term investors should be mindful that the margin of safety for U.S. stocks is eroding in this mature rally, and although near-term returns could be strong, there will likely be better gains in European and emerging market stocks. For fixed-income investors, the bond market has already discounted the Fed’s actions, and so the place to look for strong performance in 2014 could be municipals.
Optimistic Outlook for Euro Zone Equities
The ZEW survey of investor expectations for economic growth in the euro zone surprised to the upside in the December release, reaching levels not seen since 2006. Despite lackluster third quarter GDP, economic prospects in the euro zone are improving, as fiscal drag diminishes and the periphery narrows its competitiveness gap with core countries. Expectations of better growth have historically been positive for European equities, as seen by the close relationship between the ZEW survey and growth in the Euro Stoxx 50. Combined with favorable valuations relative to the United States, there is considerable near-side upside to euro zone equities.
EURO ZONE ZEW SURVEY AND EURO STOXX 50
Source: Bloomberg, Guggenheim Investments. Data as of 12/17/2013.
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