Last Friday, The Wall Street Journal released the latest Jon Hilsenrath missive on the inner workings of the Federal Reserve. His latest article shined a light on the deliberations of the Federal Open Market Committee, which oversees the central bank's monetary policies. According to the article, Fed Chairman Ben Bernanke and his team of governors are trying to find the easiest way forward that will allow the institution to both gradually withdraw its stimulus program and avoid sparking a broad sell-off in the stock market.
The problem becomes increasingly murky as you begin to look at the stock market patterns since the Fed launched the first round of quantitative easing (QE) in 2009-2010. Lance Roberts of StreetTalkLive, an independent finance blog, recently penned an insightful analysis of the history of QE and what may be in store for the stock market as the Fed pulls back its supports.
The thrust of his argument is that, despite the best intentions of Bernanke and the rest of the FOMC, a sharp correction in the stock market is increasingly likely due to the fact that a correlation can be seen between the three rounds of QE and the progression of overall stock prices since 2009. QE has effectively suppressed bond yields in a bid to push investors into riskier assets – stocks and real estate, primarily – and, as a result, the first true signs of a program cessation could cause the flow of money to shoot right back into the bond market. When this happens, Roberts is forecasting, surging risk levels might be the spark that drives the stock market down deeply in a manner more rapid than the Fed may be predicting.
"The problem with the financial markets today is the speed at which things occur. High frequency trading, algorithmic programs, program trading combined with market participant's "herd mentality" is not influenced by actions but rather by perception," Roberts wrote.
While this essay is just one analysis of the coming withdrawal of Fed market support, it's a much-needed reminder to investors to always be on the lookout for risk levels as they monitor and adjust their portfolios. In this case, The SmartStops Market Risk Barometer is a risk management tool that can be immensely useful when maintaining a steady position in the markets.
Categories: Risk Management, Trading & Portfolio Strategies