Don’t Let Feds Talk Sway You From Goals

The world’s most closely watched central bank unsettled financial markets by announcing that it may start to scale back its bond purchases later this year. Under this program of “quantitative easing,” the Fed buys $85 billion a month in bonds as a way to keep long-term borrowing costs down and help generate a self-sustaining economic recovery.

Fed Chairman Ben Bernanke’s late May comment that the central bank may start to scale back those purchases in coming meetings, gave the markets a scare. Just the prospect of the monetary tap being turned down caused widespread risk reassessment. This led to a retreat in developed and emerging economy equity markets, a broad-based rise in bond yields and a decline in some commodity markets and related currencies.

Long-term investors should consider the following varied ways of looking at these developments:

  1. We are seeing a classic example of how markets efficiently price in new information. Prior to Bernanke’s remarks, markets might have been positioned to expect a different message than he delivered. They adjusted accordingly.
  2. Since the patient is showing signs of recovery, policymakers can publicly convey a change in policy. This is not to make any prediction about the course of the U.S. or global economy, it just tells us policymakers and investors are reassessing the situation.
  3. For all the people liquidating positions in risky assets like stocks or corporate bonds, there are others who see long-term value in those assets at lower prices. The idea that there are more sellers than buyers is simply not true.
  4. The rise in bond yields is a signal that the market in aggregate thinks interest rates will soon be on the rise. That is what the markets have already priced in. What happens next remains to be seen.
  5. A rise in bond yields means a fall in bond prices. Just as in equities, a fall in prices equates to a higher expected return. Therefore, selling bonds after prices have fallen echoes the habit some stock market investors have of buying high and selling low.
  6. Volatility is usually most unnerving to those who pay the most attention to the daily noise. Those who take a longer-term approach can see these events as just part of the process of markets doing their work.

Individual investors are unlikely to have any particular insights on the course of global monetary policy, bond yields, or emerging markets that have not already been considered by the market and built into prices. Investors must manage their emotions and remain focused on their long-term, agreed upon goals. Otherwise, investors risk reacting to something that others have already priced into their expectations. Ultimately, second-guessing markets means second-guessing yourself. Stay focused on your goals and let the market work for you.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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