What To Expect From The FED

Over the last few years, we have been experiencing a very accommodating monetary policy. This policy has allowed for circumstances that are higher than ever in both the amount spent and elapsed time. The financial crisis of 2007-2009 was so harsh that central banks around the world have taken unconventional measures in order to sort out the chaos and instill economic growth. But after trillions of dollars spent by the FED, can we expect the program to continue for much longer? What are the implications for the stock market?

Over the last few FOMC meetings, some advocated the view that the asset purchase should end soon; if so, we can expect the stock market to go down more than 10%, because the US economy isn’t in great shape. When we look at valuation metrics, stocks are overvalued in the price-to-earnings ratio. The Shiller P/E ratio is currently pointing to 25.25x, while the average ratio is 16.5x. The asset purchase is driving investors out of the bond market and into the stock market, pressing prices up. When it reaches the point that the FED stops, this index will go down with most of the change occurring on the price side.

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However,  Janet Yellen is known for being dovish so the end for QE may be out of sight and seems unlikely to happen any time soon, in which case the FED will keep its asset purchase program mostly unchanged for quite some time. This will last until unemployment drops to 6.5% and GDP growth accelerates above 3%.

A few days ago, the ECB cut its key interest rate while some ECB officials made comments that ultimately ended up opening the gate for further measures. Their comments led the way for a negative deposit rate and bond purchasing. This international environment pushes the dollar up, something the FED doesn’t really want, a fact that adds more weight to those in favor of continuing monetary easing. This leads one to believe we can expect the current asset buying to stay unchanged.

In such a scenario there is doubt that any major corrections will occur in the stock market. Although the Schiller P/E points to overvaluation, the ratio will continue to rise for some time, while the FED manages downside risks. Eventually it is bound to be corrected, as it was in the case of the 2000 Nasdaq bubble–an issue of concern. Stocks are already up 150% since the bottom hit in 2009, making it time to prepare for a potential crash in order to avoid being caught off-guard. Reduce leverage and add some short positions to counter-balance portfolio risk. Gold and gold-related stocks could also help, especially since the risks of inflation are rising with the massive FED intervention.

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