Based on the 500 point selloff in the Dow Jones Industrial Average over the last two days undoubtedly many individuals are wondering what is going on. The Federal Reserve’s meeting ended yesterday with the usual statement and press conference by Ben Bernanke. As you could see from the market reaction, what was discussed was far from the usual.
The immediate market reaction to the announcement has been twofold: interest rates are ticking up, and stock and bond prices are ticking down. Why? Markets are forward looking, and traders are trying to get ahead of future movements. For interest rates, if the Fed will be pulling back, the perceived time to sell is now, rather than later. The problem is that traders don’t have a good handle on what interest rates should be in the absence of the Fed. Markets have been so distorted for so long that there has really been no price discovery.
Stock markets have the same problem, plus the very real concern that if the Fed pulls back, the recovery in the real economy may not be strong enough to continue without that support. If the real economy pulls back, the effect on the stock market could be twofold, with the repricing of risk combining with the effect on earnings of a weaker economy.
Part of the market reaction is the volatility that comes from any significant economic change, part is a real repricing of risk, and part reflects very real potential economic changes that will result from the Fed’s withdrawal. In the short term, expect to see a continued pullback, as investors cautiously try to figure out the new landscape. After that, expect some recovery from the initial overreaction. There are reasons to believe interest rates may stay at low levels, even as the Fed pulls back, and once this becomes clear, caution may abate and prices recover. Please read the attachment for more on where stocks, bonds, and interest rates could be headed. Naturally, call or email me with questions and have a good day.
Gerald Loftin, CFP®, AIF®
Proficient Wealth Counselors, LLC