Read full article at: http://seekingalpha.com/article/2615715-a-once-in-a-generation-change-for-stocks?ifp=1
The Implications For Financial Markets
Mr. Greenspan has already spoken and apparently his inclination is to be long gold (NYSEARCA:GLD). This opinion is highly ironic coming from a former Fed Chair. But what was even more notable was that Mr. Greenspan in his recent speech essentially affirmed in a more explicit way what Ms. Yellen implied during her October 17 speech. The conclusion, Fed policy, particularly during the post crisis period, has not worked. And when something has not worked, it is time to change.
So what does this dawning generational change in Fed policy mean for financial markets in general and stocks in particular. The Fed may no longer wish to further inflate stock prices to new heights. But they also have absolutely no interest in allowing the stock market to completely collapse either. For the moment, the stock market as measured by the S&P 500 Index (NYSEARCA:SPY) starts going down in a sustainable way, the focus in the media quickly turns to all of the things that are actually wrong with the U.S. and global economy (and there is an abundance of such things to focus upon), which can have a compounding effect to the downside for not just the markets but the economy as a whole. But given the fact that stocks are currently trading at lofty valuations, the likely move without the support of further policy stimulus is to the downside as stocks seek to find their true equilibrium price. In recognition of this fact, the most desirable outcome for the Fed, particularly if they wish to close the inequality gap moving forward, is to let the air out of the stock market very slowly in fits and starts over the next few years. Such is the makings for the long, slow, grinding bear market that would mark the third and final leg lower in the traditional secular bear market cycle, as the cleansing process is finally allowed to play out along the way. In an upcoming article, I will explore in more detail the implications for stock valuations if the Fed is indeed embarking on a different path for monetary policy going forward.
As for the fate of Treasuries (NYSEARCA:TLT), this will continue to rest in the hands of the economic outlook. In a reality that appears to finally be dawning on investors six years after the fact now, Treasuries perform well when the Fed is NOT buying and struggle when the Fed IS buying. The rally in Treasuries began just days after the Fed's tapering of QE3 began, and as long as the economic outlook remains challenged, Treasuries should catch a nice bid.
The same cannot be said for spread product such as investment grade corporate bonds (NYSEARCA:LQD) and high yield bonds (NYSEARCA:HYG). Just like stocks, these categories have benefited from the lower risk environment provided by Fed asset purchases. But with interest rate spreads relative to U.S. Treasuries at historically low levels, the risk is to the downside for these categories as these bonds are forced to once again deal with the realities of the economic cycle. These downside risks are particularly pronounced for high yield bonds, where the credit risks being assumed in this area of the market have been of increasingly speculative proportions to be kind.
Bottom Line
The three decade long era of Fed support for stock prices appears to be coming to an end. In its place is the dawn of a new era of Fed policy that is likely to be more targeted with its policy initiative with a focus on the bottom 95% that has been left behind from an employment, income and housing perspective. Whether the Fed will be successful with these priorities remains to be seen. But given their priority to address what their Chair perceives to be among the worst inequality conditions in American history, any future support that passes through to the stock market is likely to be nil barring some sudden and catastrophic decline in prices along the way. If this is indeed the new reality for stocks, it is important for investors to begin prepare for this reality today, as stock investors may finally be forced to truly work at generating positive returns without the free pass they have been receiving for nearly three decades.
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