This Just In: Market burps at the death of ZIRP
Timely perspectives on recent stock market volatility, April 11, 2014
Bill Hackney, Managing Partner, Atlanta Capital Management, LLC
Lower-quality and smaller-capitalization companies have led the bull market of the past five years. Underpinning their strong performance has been an extraordinary period of easy money characterized by the Fed’s zero-interest-rate policy (ZIRP), affecting short-term rates and quantitative easing (QE) that pressured long rates lower.
The recent market correction signals that an important inflection point has been reached: The end of extraordinarily easy money is now in sight. The Federal Reserve is scheduled to end QE in October and Fed Chair Yellen recently stated that six months later short rates could begin to rise. Investors are understandably nervous about the Fed’s ability to engineer a “return to normalcy” following a period of easy money that is without precedent in American history. That’s why the more speculative areas of the stock market – social media and biotechnology stocks, small-cap and lower-quality stocks – have taken such a beating in recent weeks.
In our view, the bull market in stocks is not over; it’s just reaching middle age. From here on, we believe leadership is likely to shift from smaller-cap and lower-quality to less expensive stocks found between the larger-cap and higher-quality issues. With monetary policy becoming less accommodative and the economic cycle maturing, equity investors may increasingly be concerned about issues of liquidity, earnings consistency and downside protection. These are the very qualities that characterize most large-cap, high-quality stocks.
What we’ve seen so far in 2014 is a stock market that is relieving a little bubble-like pressure that’s built up in its most extended and expensive sectors. It’s a burp, not a heart attack.
Eric Stein, Vice President, Co-Director, Global Income Group, Eaton Vance
- Market reactions to Fed policy – particularly in interest-rate and currency markets – have been stronger than they probably should be in both directions – though if we’re at an inflection point, this is understandable.
- The inflection point is that the Fed seems to be on a pretty clear path to tightening, QE taper is on a preset course and fed funds rate appears likely to rise during the second half of ’15 or Q1 ‘16.
- The Fed has been suppressing volatility and driving asset prices higher and higher over the past five years with ZIRP and QE, while the real economy has been slowly improving.
- As such, it is possible and perhaps even likely that we continue to have a gradually improving real economy, but asset prices become more volatile, with valuations appearing stretched in many areas and as the Fed unwinds.
Richard Bernstein, CEO and CIO, Richard Bernstein Advisors LLC
Markets often see more choppiness during parts of the midcycle because fiscal stimulus typically ends and the Fed begins to reverse course. That seems to be the situation today, and suggests the recent volatility might be more normal than many investors believe.
One has to be careful not to let normal midcycle volatility outweigh the search for opportunity.
The views and opinions expressed by the author are those of his own as of the date indicated, and do not necessarily represent the views of Eaton Vance. Any such views are subject to change at any time based on market or other conditions and Eaton Vance disclaims any responsibility to update such views.