Investment Contrarians

Federal Reserve Shocks the Market; How to Protect Your Wealth

By for Investment Contrarians |

Federal Reserve Shocks the MarketAccording to the minutes from the Federal Reserve meeting on December 11–12, it now appears highly likely that the aggressive quantitative easing policy might end sooner than most people had expected. This is a shock to many market participants who had expected an extended period of time under the current quantitative easing policy by the Federal Reserve.

The minutes of the Federal Reserve meeting show that several members stated they believe that the current quantitative easing policy will end, “well before the end of 2013.” Other Federal Reserve members expressed their opinion that this quantitative easing policy will need to be completed by the end of 2013. Many market participants expected this current quantitative easing policy to last well into 2014, perhaps even into 2015. (Source: “Minutes of the Federal Open Market Committee,” Federal Reserve, January 4, 2013.)

The reason this statement is so important is that multiple Federal Reserve members voiced concerns and were of the opinion that the current quantitative easing policy needs to be reduced or completed sooner rather than later. While there was one Federal Reserve member who stated at a meeting before that no further bond purchases are needed, one voice is not enough to alter the opinion of an entire committee. But now, there are many Federal Reserve voices raising concerns.

Because this is the first real evidence that a large number of Federal Reserve committee members are voicing the opinion that the current quantitative easing policy will need to end relatively soon, one must take note. This is a pivotal point for potential change in monetary policy.

With this in mind, if the Federal Reserve were about to begin reducing its quantitative easing policy, this would certainly be bearish for bonds. As I outlined in my article “The Worst Investment for 2013 and the Next Decade,” being invested in bonds at this point is extremely dangerous.

That article was written prior to the release of the minutes from the last Federal Reserve meeting. Now that we are aware of concerns by the Federal Reserve and of an interest by several members to reduce quantitative easing much sooner, bonds become an even worse investment.

This indicates a high probability that this is the very beginning of the end for quantitative easing. If we now try to forecast the next five to 10 years for Federal Reserve monetary policy, we would see the reduction in quantitative easing and higher interest rates. This is extremely toxic for bonds, as witnessed by the 10-year Treasury note’s rise to 1.91%, up 0.07% in one day, with the price falling. It won’t take long to see a substantially higher rate and lower price for U.S. bonds and notes.

One of the key determinants for the Federal Reserve in reducing quantitative easing is the labor market. Two important data points to look at include: a) the ADP National Employment Report; and b) the Employment Situation from the Bureau of Labor Statistics.

I prefer the ADP National Employment Report from Automated Data Processing, Inc. (ADP), as these are hard numbers from 406,000 businesses employing over 23 million workers. However, I still do incorporate the Bureau of Labor Statistics into my economic analysis for a better overall picture of the economy.

For December, ADP reports that private employment increased by a stronger-than-expected 215,000 from November, as well as an upward adjustment of 30,000 jobs for November. Construction continues to gain a substantial amount of jobs as the housing recovery continues. In addition, the transportation and utilities sectors, along with the professional business services area, continue to generate jobs growth. This is the strongest monthly jobs gain since February of 2012. (Source: ADP National Employment Report, Automated Data Processing Inc., January 3, 2013.)

According to the Bureau of Labor Statistics, the December nonfarm payroll increased by 155,000 jobs. Unemployment remained at 7.8%, well above the rate the Federal Reserve would like the economy to achieve. Most of the underlying data were relatively flat month-over-month, except average hourly earnings for all employees, which increased to $23.73, up $0.07. For 2012, average hourly earnings increased by 2.1%. One surprise was that November’s nonfarm payroll was revised upwards to 161,000 jobs from 146,000. (Source: “Employment Situation Summary,” Bureau of Labor Statistics, January 4, 2013.)

These numbers are not exceedingly strong. However, they do show that the economy is not losing jobs but is in a slow recovery. This is a tough situation for the Federal Reserve. In my opinion, the unprecedented level of quantitative easing has to end soon to avoid unintended consequences.

I do believe that extreme quantitative easing measures might be prudent during a financial crisis. Clearly, we are not in a financial crisis, as many metrics are showing positive signs. I think it would be extremely dangerous to continue this quantitative easing policy well into 2014, and I am of the opinion that we could certainly reduce, or eliminate, most, if not all, of this quantitative easing policy.

With this in mind, how should one structure their investments? With fewer purchases of bonds by the Federal Reserve and higher interest rates to come, avoiding bonds makes the most sense. I also believe that we will see a significant rush of assets from bond funds into the equity market.

We now have the first indications that the Federal Reserve is about to change its monetary policy stance with regards to aggressive quantitative easing. Historically, when the Federal Reserve begins a policy action, it tends to run for an extended period of time. This means that, in my opinion, investors should avoid bonds for a substantial amount of time.

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