Keep Calm and Chive On So To Speak

On Wall Street emotions turn on a dime.  Optimism one day.  Despair the next.  In the past two trading sessions the Dow Jones Industrial Average has lost 559.91 points, or 3.66%.  The sell-off was sparked by what Fed Chairman Ben Bernanke said and didn’t say about the Fed’s easing program and the growth of the U.S. economy.  So what exactly did the Fed Chairman say to cause such a violent sell-off?  And was any of it a surprise?

Essentially Bernanke said the Fed does not expect to start raising its key interest rate until probably the first half of 2015 and that the Fed could start to taper the quantitative easing program late this year, ending the purchases entirely in mid-2014. So how does quantitative easing affect the stock market?  You can read my April 5th blog post “Why the Fed and Monetary Policy Matter–Made Easy.” for a full explanation on the Fed and quantitative easing.  But for a specific understanding of how Fed policy affects stock prices below is an excerpt:

“So why do we care about this?  Two reasons.  The first is that while I am a long-term bull on the U.S. equity market, in the short-term, much of the appreciation in stocks which began in 2009  has been fueled by QE. By keeping interest rates so low the Fed is encouraging investors to turn to the stock market for higher returns.   The second reason is that flooding the economy with currency to fund unchecked government spending (recall that the Senate hadn’t passed a budget for the previous four years until a few weeks ago) can lead to inflation and very slow growth in the real economy.

So don’t get caught up in the short-term, day-trading hype propagated by the financial media.  Stay the course.  Buy great companies for the long-term. Over a reasonable period of time the stock market averages approximately 9% per year even when all the bear markets are included.  But, buy quality.”

Mr. Bernanke’s reason for potentially tapering the easing is that the downside risks to the economy have “diminished since the fall” when the latest easing program began.  That should be good news for investors.  And it is.  But for traders, the ones who move the market in the short-term that means the easy money has been made and they must work harder to identify great companies that are trading at a discount; they may also have to extend their time horizon and think more like investors.  Since that is how we select stocks nothing much has changed for us except that we may have the opportunity to buy more of the great companies we already own at cheaper prices.

A few weeks ago I wrote a piece on Cisco (CSCO) that was syndicated by The Motley Fool.  The fundamentals that made CSCO a buy one week ago are still intact and I intend to use any weakness to add to my holdings.

I’ve said it before and I will say it again:  Buy Great Companies for the Long-Term.

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Tune Out the Daily Commentary and Buy Great Stocks for The Long-Term

One of the most difficult things for budding investors to understand is the relationship between the bond market and the stock market.  If you listen carefully through the cacophony of financial pundit prognostications you will discern that the primary reason the stock market is powering up this year is because the Fed continues to buy treasuries and mortgage-backed securities to the tune of $80 billion a month–Quantitative Easing (QE)– keeping liquidity high and bond rates low.  And, that is, for the most part true. (See my previous post:  Why the Fed and Monetary Policy Matter-Made Simple in the Arizona Republic.)

But the punditry volume increases when the discussion turns to how the stock market will perform when the Fed steps back from QE and the inevitable rise in bond rates begins.  That debate ratcheted up in the last week as investors worried that the Fed would begin to “taper” their QE and bond rates would rise.  (It should be noted that treasury bond rates have risen from a recent low of 1.6% for the ten year bond to 2.175% at today’s close.)

So can the stock market continue to perform in the face of rising interest rates?  Generally the conventional wisdom would say “no”–as bond rates rise, the stock market declines and vice versa. But, during the 1950’s and 1990’s the stock market continued to perform well in the face of rising interest rates.  According to the Leuthold Group as reported in Barron’s this last week, in the 1990’s the Dow Jones Industrial Average (DJIA) generated an average annual return of “15.7% when corporate bond prices fell” and rates rose (emphasis mine).   During the 1950’s the returns were not as impressive but still robust.  The DJIA rose 10.8% per year on average when bond rates increased.

Continue to build holdings in high-quality, industry leaders with steady growth.  Most stocks are not expensive by any historical measure.  Buy quality for the long-term.  That is investing.  The rest is just noise.