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VOL. 38 | NO. 26 | Friday, June 27, 2014

Calm amidst the ‘storm’

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The S&P 500 continues to inch ever so closer to the 2,000 mark, while volatility measures remain historically low. Furthermore, there have been 43 consecutive days where the S&P 500 has registered a daily return mark within the -1 percent to +1 percent band.

However, from a newsreel perspective, there seems to be multiple reasons for investors to be experiencing stormy waves, as opposed to the smooth sailing that has been present of late. Whether it is gas prices at $3.50/gallon, terrorists conquering city after city in Iraq, tanks rolling into the Ukraine, emails vanishing/hard drives destroyed or tea partiers disrupting the power structure on Capitol Hill, there are many, many headlines that would seem to give investors pause.

Why then the lull? One factor was on display last week, as the Federal Reserve (the Fed) concluded their most recent two-day policy meeting. Chairwoman Janet Yellen revealed that the Fed showed no signs of turning off the spigot. It will continue purchasing mortgages and Treasury bonds, albeit at a slower rate.

On the short-term interest rate front, Yellen said that, “economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Therefore, neither the Fed nor many other central bank outfits across the globe appear to be anywhere near a tightening stance at this point. Why bother fighting the Fed?

Before you get too comfortable, though, what are some risks from this continued aggressive stance? Although there are many, here are two. For one, witness May’s Consumer Price Index (CPI) report released last week. It revealed a 0.4 percent month-over-month increase, bringing the annual inflation figure up to 2.1 percent. These numbers are definitely on the upswing and move the deflation fears closer and closer to the back-burner. If an unexpected inflation spike is out there, then investors will start to think the Fed has overshot its generosity.

Second, there is always the risk that the investing public becomes too complacent. It seems upside down, but from a contrarian’s point of view, low volatility and excess investor comfort can be a little disconcerting, because it means the retail investor is becoming numb to volatility. This was illustrated perfectly when I recently saw the following headline:

“Be fearful: This chart’s predicting a 5% pullback”

I’m sorry, but I chuckled when I read those words. Last year and this year have seen an unusually low level of peak-to-trough pullbacks in the market, making investors think that is the norm. However, it is not. Five percent to 10 percent pullbacks in the stock market happen quite often. So often, in fact, that if a 5 percent pullback in the market instills fear, an investor does not need to bother with investing. This is not to minimize anybody’s discomfort with seeing losses on hard-earned assets.

However, life will be lived in continual fear if 5 percent downturns are the cause, so it would be much better keep the money buried in the backyard.

So, don’t fight the Fed for now, but always keep a long-term perspective in mind, even whenever more significant market moves return.

Mark Sorgenfrei Jr. is vice president and investment analyst for Waddell & Associates Inc.