Forget the Fed: Why Investors Should Ignore Central Bank
Markets and the economy will have to fall much more to trigger Fed action.
Market strategists advocate betting against consensus on central bank moves.
With the stock market and economy likely nowhere near the depths that would warrant further Federal Reserve intervention, investors may be better off putting more stimulus out of mind and focusing elsewhere for now.
Despite the troubling signs of recent days — a weak jobs report and a 4 percent stock marketslide over the past week — many Fed watchers say the central bank and its Chairman Ben Bernanke have no plans for action.
That's an important notion to accept for investors, particularly those who clamor for help every time the economy or markets show the slightest blip.
"Expect (Bernanke) to continue using the normal channels of communication to convey the likely direction of policy: Public speeches, press conferences, directives and meeting minutes," Ralph Axel, rates strategist at Bank of America Merrill Lynch, told clients.
"Ignore the hype in the meanwhile, and avoid looking for complex signals or hidden political agendas to trade changes in Fed policy," he added.
In fact, BofA recommends clients proceed not in anticipation of more Fed bond-buying, but rather to act as if quantitative easing is not on the horizon. Axel argues, in effect, to try to front-run the front-runners who are betting on more easing.
Three-year Treasury notes, for example, make a good contrarian investment against consensus expectations that the Fed will extend the Operation Twist program and thus add to selling pressure for shorter-dated government debt. The Twist entails the Fed selling shorter maturities and buying an equal amount of longer debt to drive down borrowing rates.
The BofA strategy is a play, instead, that the Fed Open Markets Committee first will hold to its pledge to keep rates low, and then deal with further easing measures later.
"Rather than tweaking the balance sheet in April, the FOMC statement is more likely to reinforce the message conveyed in January: Rates are likely to stay on hold at least through late 2014," Axel said.
BofA also advises that the climate at least in the near term for inflationbreakevens and in mortgage-backed securities — the latter being the likely target should a third QE round materialize — will remain volatile as the Fed provides no help for now.
The stock market also could wobble because of all the unwarranted Fed anticipation, said Andrew Wilkinson, chief economic strategist at Miller Tabak in New York.
"It used to be the case that marginally soft data could be dismissed simply because of the strong likelihood that the Fed would come rushing to the rescue," Wilkinson said. "Growing impediments such as disparate FOMC voices leave equity prices vulnerable to softer data."
Yet if the short history of QE is any sign, it will take quite a bit more damage to precipitate a Fed move to save the market.
"The Fed appears to look at a variety of factors in deciding its actions. What's unique about their behavior currently is they are explicitly looking at the stock market," said Lawrence Creatura, equity market strategist and portfolio manager at Federated Clover Capital Advisors in Rochester, N.Y. "That's something new. They do have one eye on the stock market, and it does influence their decision-making."
But double-digit percentage drops in the market have preceded QE1 and QE2, as well as Operation Twist, meaning that a modest drop in the major indexes is unlikely to get the Fed's attention.
Besides, it's arguable as to whether the central bank's machinations really have been such a driver in stock market prices, even though QE2 and Operation Twist in particular have preceded sharp market moves upward.
"When measured against real assets such as gold and oil, stocks are worth less now than when QE started," Joseph Calhoun, founder of Alhambra Investment Partners in Palmetto Bay, Fla., told clients. "For leveraged speculators with a knack for anticipating Fed policy, QE has been a boon. For everyone else it has, at best, only kept things from getting worse."
Calhoun advises not front-running the Fed but rather taking a cautious and conservative approach until the central bank's position becomes clearer.
"The Fed is apparently on hold for now and that hasn’t been a good time to be long risk assets over the last few years," he said. "I don’t think this time will be any different and so, once again, we find ourselves sitting on more cash than we’d like. I suspect it will be better than the alternative for the foreseeable future."