If Janet Yellen gains Senate approval in the coming days to become the next Federal Reserve (Fed) Chair, she’ll take over on February 1.1 Investors are almost certain to watch her closely from day 1, searching for any kinds of policy-setting signals she might give. We believe the key factors to watch are how and when she intends to pare back the quantitative easing programs, better known as QE.
Based on Yellen’s testimony before the Senate Banking Committee, her letters to lawmakers, and her track record, she appears in favor of continuing stimulus measures. This could mean an extension of the current quantitative easing programs with the Fed also holding their benchmark interest rate close to zero throughout all of 2014, which could be a positive for the economy and for portfolios.1 On the other hand, if market participants believe the Fed to be paring back those programs prematurely, it could be a negative event for the markets.
Investors should speak with their financial advisor to find out if their portfolios are positioned with these monetary policy outcomes in mind.
In our newsletter about fixed income strategy, we discussed the potential impact of rising interest rates. This could be a factor in 2014, because even as Janet Yellen may maintain QE for a bit longer than originally planned, it’s possible that at some point next year the Federal Reserve will begin to taper those programs. This could put upward pressure on longer-term interest rates.
Should Investors with Income Needs or Fixed Income Allocations Make Changes?
For investors with an income-driven portfolio strategy, this could be a call-to-action. If your portfolio is allocated strictly toward longer-term bonds, for instance, there could be alternative strategies that may make more sense for you in a rising interest rate environment. There are also other income options for investors looking to diversify some of their portfolio away from bonds—allocating a portion of your portfolio toward dividend paying stocks is an example of one option to explore.
What Happens to Portfolios When Longer-Term Interest Rates Rise?
As longer-term interest rates rise, the prices of longer-term bonds fall, so that particular category of bonds may underperform. We believe investors should have a diversified fixed income portfolio that has various types of bonds within it, so that if one category of bonds underperforms, you have exposure to other types of bonds that may do better over that same period.
Navigating the bond world can be tricky, so it’s important you speak with your financial advisor or one of our Wealth Managers to learn more about how to properly diversify your fixed income portfolio—or even shift a portion of your portfolio to dividend paying stocks—to anticipate changes in the interest rate environment.
The US government is currently funded through January 15 of next year, and there is a budget conference in Washington working on a government budget for the next two years. If the House Appropriations committee doesn’t get that budget in time, they might not be able to appropriate funds beyond that January 15 date, and the government could shut down—again.2
What does this mean for your portfolio?
The most recent government shutdown took place from October 1 – 16.3 Below, you can see that there was a bit of negative movement in early October, but it was only short-term and the upward trend of the market continued. In short, the market shrugged it off. We think the market reaction could be similar if the government were to shut down again.
S&P 500 from January 1 – December 1, 2013
(Click chart for larger version)
Source: St. Louis Federal Reserve
Separate from the shutdown issue is the debt ceiling, which the US is set to hit again sometime in March (some estimates have it pegged in May-June).4 Last time, there was quite a stir in Washington over raising the debt ceiling, but once again the market seemed to ignore it for the most part. The debate got heated around the September-October timeframe,4 and the market did just fine:
S&P 500 From September 2 – November 1, 2013
(approximate timeframe of debt ceiling debate)
(Click chart for larger version)
Source: St. Louis Federal Reserve
If there is another government shutdown or uncertainty about the debt ceiling again next year, expect a decent amount of drama leading into it, but hopefully a whimper-like impact similar to last time. A properly diversified portfolio may help weather any mini-storm that brews in Washington as a result.
Earlier in the year, we wrote about how often stock market corrections typically occur within a bull market cycle, and we discussed ways investors could approach them.
You might remember this chart from our earlier writings:
Historical Yearly Stock Market Corrections
(Click chart for larger version)
Source: Standard & Poor’s, FactSet, J.P. Morgan Asset Management. Returns are based on price index only and do not include dividends. Intra-year drops refers to the largest market drops from a peak to a trough during the year. For illustrative purposes only. Returns shown are calendar year returns from 1980 to 2012, 2013 numbers represent year to date returns. “Guide to the Markets – U.S.” Data are as of 9/30/13.
Even though the market has average intra-year drops of 14.7%, as you can see in 2013 the biggest pullback we’ve seen as of September 30, 2013 was only to the tune of 6%. As stock market corrections are normal in bull markets, we would not be surprised to see an averaged size correction during 2014.
A properly diversified portfolio is important for handling a stock market correction, but weathering corrections requires a good deal of investor patience. Remember, by definition corrections are short-term pullbacks within an upward trending bull market.5 Participating in the downside of a correction isn’t necessarily a bad thing, if you manage to capture the recovery and the upside afterwards. It’s just important to make sure you have a properly diversified portfolio so you’re ready.
Categories of stocks or bonds that did well in 2013 may not necessarily be the top performers in 2014. For example, US stocks have widely outperformed Emerging Markets stocks so far in 2013, but will that be the case moving forward?6 The New Year is a good time to look at your current asset allocation with your financial advisor, so as to determine what did well, what didn’t, and why.
As we know, past performance isn’t an indicator of future performance, so focus less on what did well previously, and instead be thinking about what could do well in 2014, and make adjustments as needed. Talk with your financial advisor or one of our Wealth Managers about the outlook for 2014 and whether your portfolio is positioned in accordance with the themes that might outperform.
Also important in this process is to assess the performance of your money manager strategies and to review your investment plan, your spending needs for the New Year, and so on. If changes need to be made, handling them at the beginning of the year can help you prepare your portfolio for the rest of the year.
One of our Wealth Managers can help you address any and all of the points above, and we can also help you analyze your current situation and portfolio to ensure you’re prepared for the year ahead. Give us a call at 800-544-7771 to speak with us about how we can help. You can also get started now by answering a few questions here.
Sources:
3 CNN