23 Sep

The Punch Bowl Going Away? Not So Fast

At the end of May (see prior blog post http://www.epiqpartnersllc.com/blog/item/50-hold-on-change-is-likely-and-we-believe-it-is-good), we expressed an opinion on the Federal Open Market Committee (FOMC or 'the
Fed') that if it chose to begin winding down its unprecedented bond-buying program, it would be a good sign and welcomed by the market.  Since then no significant change took place, and while that was good for equity investors (and not so good for fixed income markets), it's clear to us that it could be some time until the Fed begins to pull back from that program.

As the memory of the financial collapse of 2008-2009 grows more distant, remember that a great deal of the recovery is due to the tsunami of cheap money that the Fed (and other central banks) has poured into the
economy.  Even though domestic and international economies are improving, they are not cured.  In fact, we are far from it.

The FOMC has indicated that it will not consider a policy change until US unemployment falls to 6.5%. Don't expect much until this metric is in sight.  The seemingly inexhaustible improvements that technology has asserted on workplace productivity suggests that we will need to experience significantly more economic growth to help outpace the productivity growth with the need to hire new workers. Clearly, the Fed sees the weakness in the labor market and housing market, particularly when a move of less than a percentage point in mortgage rates can slam on the brakes in home purchases and refinancings.

We will know the economy is healthier when the Fed reverts to its methods of gently influencing economic activity when the Fed Funds Rate is somewhere between 3% and 6%.  Right now we are at 1/8th of 1% (.125%). The gap between these two rates, coupled with what will have to be a careful and graduated pullback in the Fed's $85 billion in monthly bond purchases, will likely take years to accomplish.  Forecasters originally predicted that rates will start to rise this fall.  Today, the markets indicate that the date is now pushed off until September of 2015.  We just hope that is can happen this decade!

The result of the current course is that those who own equities are likely to continue to benefit at the expense of those who are focused on bonds.  The interest paid and potential for capital appreciation does not compensate a fixed income investor when inflation is part of the equation.

Does this mean that stocks are the best solution for today?  Perhaps, but it does not come without risk.  We fully expect that broad-based equity markets will be higher in the years to come.  It will not be a straight line, and won't come without some significant periods of volatility (i.e., market declines).  But don't expect a spike in interest rates anytime soon.

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Would you believe EPIQ Partners has been around for one year?  Thanks to all who have made the past year fun, rewarding, purposeful, and prosperous.

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