federal_reserve

It was a tumultuous week for the markets, thanks in large part to an announcement out of the Federal Reserve. Let's examine 1) what exactly the Fed said, and 2) the market's reaction.

Firstly, was there really something different the Fed said that it hadn't addressed before? We don't believe so. The language of the official release was similar to the previous release with a few positive exceptions, but on the whole the message was relatively unchanged.

Read: Bernanke clarifies Fed QE plans

However, Ben Bernanke did directly address the question of "tapering" bond purchases (or quantitative easing) by stating the Fed could be in a position to start reducing those purchases towards the end of 2013 and could eliminate them altogether sometime in 2014 if positive economic conditions warrant such a policy change. In other words, if things get better we'll buy fewer bonds, if they don't then we'll keep buying US$85 billion a month.

As Bernanke would say, such a decision is "data dependent." While the Fed directly addressed this issue, it did not commit to any specific timetable or provide any guarantees as to when this round of quantitative easing would come to an end.

Now let's address the market reaction. A reduction in bond purchases can be interpreted in two ways. First, by removing stimulus the Fed should be signaling that the economy is improving, therefore equity markets should appreciate. Let's call this the bullish point of view.

On the other hand, the bears would argue that equity markets have been propped up by Fed stimulus; therefore, if the Fed is going to remove this support then it's only natural that equity markets should fall. Clearly the bears have won this argument over the past couple of days.

However, if the Fed does make a decision to "taper" then it can only be because they feel confident in the sustainability of the economic recovery. So, while the bears may have won the argument in the short term, the bulls have the opportunity to win the argument in the long run.

Read: Don't fear the end of Fed QE

After all, do we not want to return to a normal investing environment where the market is no longer propped up by monetary policy? Do we not want to invest our money without always wondering what the next "shoe to drop" might be? Why is it that so many traders seem afraid of a recovery? Instead of fearing it, they should be embracing it.

If you believe, as we do, that the U.S. economy is in the midst of an economic recovery (albeit a slow one), then we continue to believe equities are where you need to be. We recognize the eventual "tapering" process by the Fed will act as an overhang on equity markets for the next few months, which may hold back returns, but in the long run investors will be better off investing in a world without central bank interference.

TRADING WEEK AHEAD

Thankfully there are no central bank meetings of note next week. There are a few data points of interest on the economic calendar as regional manufacturing, housing and GDP data will be released in the U.S., while GDP for April will likely be the only data point of note in Canada.

Read: Sluggish Chinese growth puts commodities "on alert": BMO

Even though most large cap companies have reported earnings for the quarter, there are still a few names with non-calendar year-ends that are expected to report in the coming week. NIKE Inc., General Mills, Walgreen and Monsanto top the list in the U.S., while BlackBerry, Empire Co. and Shaw Communications will report in Canada.

The direction for commodity markets will likely be determined by the direction of the U.S. dollar again. If the dollar continues its recent climb then commodity prices could come under further pressure. However, we wouldn't be surprised if the recent surge starts to level off in the near term, but stronger than expected economic data could certainly add support to the Greenback and move the dollar higher. As goes commodity prices, so goes the Canadian dollar as the loonie will also look to the U.S. dollar for direction as it tries to remain above the US$0.95 level.

Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends.
@Gareth_RGMP
Originally published on Advisor.ca

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