The big thing about this week is that the Federal Reserve brought forward its timeline to tapering its bond purchases and raising short term interest rates.
But was it really a big surprise? No. I think the big surprise is how off sides investors were heading into the FED's FOMC (Federal Open Market Committee, the voting body of the FED that controls monetary policy like bond purchases and interest rates).
I've said many times that stock valuation is a terrible timing tool for buys and sells. Expensive stocks could become more expensive. But when there is a catalyst that causes a down market, high value stocks do tend to have a magnified reaction to the downside.
Highly valued work from home/pandemic stocks tanked when the economy began to reopen. Now, reopening stocks are tanking after a substantial run which stretched their valuations. Cyclical stocks, those that are sensitive to the economy, lose investor enthusiasm when the FED becomes hawkish because it's interpreted to be a weight on the economy. For the economically sensitive stocks, the FED course correction was the catalyst for a directional change and their valuations were the weight. So, valuation doesn't determine direction, but it could determine magnitude of movement.
This is why I preach diversification; why I say don't invest in only pandemic or reopening stocks. You need both. It's why I say to rebalance between the two. Take a little off the table when a stock or sector rises. Reinvest in a sector that recedes. Do both a little at a time.
A new monetary policy regime has long been expected. The rising inflation that the FED is pointing out is not a surprise. FED Chairman Jerome Powell has pre-wared us that tapering QE is not too far into the future. This week, the FED acknowledged everything we knew already. Bringing forward the timing of the end of its ultra loose monetary policy isn't exactly a shock. Yes, stocks are generally falling this week, after hitting new highs last week. But I wouldn't go so far as to call this week's market action a plunge. Maybe if stocks sink for another week, I'll call it a mini-taper tantrum.
Now, investors have to contemplate whether or not stocks of both ilk, pandemic and reopening stocks, could make it back to their recent all time highs. The massive amount of enthusiasm for each group was anything but common. And therein lies the limits of diversification. It's good to have stocks that rise while others fall, but in a generally down market, diversification won't prevent your portfolio from going down. This means long term investors will have to bide their time. That is, If we are actually in a market that goes down for an extended amount of time.
For now, I'm still in the camp that believes today's inflation will be transitory. My comments on CNBC this week say that:
“Predicting inflation basically means predicting interest rates. It’s been a fool’s errand for the last 12 years,” said Mitch Goldberg, president of investment advisory firm ClientFirst Strategy.
He expects broader inflation caused by supply imbalances to be transitory and ultimately mitigated by greater production levels globally, while wage inflation may prove stickier, but manageable, with a big piece of the spike in wage growth related to short-term boosts and one-time bonuses. READ HERE for more
On top of everything going this week, the second half of June is typically a weak period for stocks. But that's often followed by a rebound.
I don't think anyone, myself included, is willing to call the end of the powerful bull run that's been stampeding since last year. But I do think now is an opportunity for investors to reassess their risk tolerance.
If you find economic policy interesting, you're going to be in for a real treat. Things are about to get much more interesting. But like that old Chinese curse goes: may you live your life in interesting times.
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Thanks and see you next week,
Mitch
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