The Fed Plans Its Exit from Stimulus

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Jul 10, 2014 10:44:00 AM

and tagged Commentary

Leave a comment

exit from stimulusThe release of the Federal Reserve’s June meeting minutes was a case of no news is good news.

Even after the weak first quarter, the Fed believes the economy is continuing to recover, and that the risks are now pretty much equally balanced between faster and slower growth. The discussion seems to have shifted from whether the recovery is valid to how quickly it’s movingand the burden of proof is slowly shifting from those who want the Fed to back off to those who want it to keep stimulating.

That’s a big, if slow, shift in perception.

Fed eyes October end date

Policy is moving even more slowly, but it is moving. For the first time, the Fed has explicitly stated that it's planning to exit from stimulus at a specific date, in October—subject, of course, to economic and financial conditions. Discussions have also started, in a serious way, about when and how to deal with the reinvestment of existing holdings, and about actually increasing interest rates.

The market’s reaction to the Fed's plans was interesting. After two days of declines—led, in my opinion, by worries about earnings—we saw a small rally, which first slipped but then recovered when the minutes were released.

Good news, all around

As I read the minutes, the news is almost all positive. The recovery continues, and is accelerating. But even as it plans to stop buying bonds—a vote of confidence in itself—the Fed also indicates that it intends to keep rates lower for longer, and to manage the process to maintain as much stimulus as possible.

From a growth perspective, this is the best of all worlds: a solid recovery that will continue to be juiced by low rates and accommodative policy.

Even with this very positive backdrop, the Fed’s growth expectations are still modest from a historical perspective. 2014 growth is expected to be below 2.5 percent on a real basis, while 2015 growth is projected to be around 3 percent. Longer-term growth is expected to remain below 2.5 percent, which is potentially a problem for markets.

Can earnings keep up?

Earnings, meanwhile, are expected to grow substantially faster, even as revenue growth is constrained by the growth of the economy as a whole. In order for earnings to meet expectations, either profit margins have to move even further into record territory, or stock buybacks have to continue at their record pace.

I’ll discuss earnings more tomorrow. For now, though, the idea that economic recovery will justify current valuations is starting to look questionable, even using the Fed’s relatively optimistic expectations.

5 Ways to Affiliate
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Subscribe via E-mail

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®