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Investment Strategy

Buy the Dips: Our 2014 Market and Economic Outlook

By Elliott H. Gue, on Dec. 18, 2013

Regardless of the timing of the Fed’s plan to scale back quantitative easing, fears that the Great Taper will short-circuit the US economic recovery and the stock market rally appear to be vastly overblown.

Fed Chairman Ben Bernanke and his presumptive successor, Janet Yellen, have made their position abundantly clear: The timing of the Fed’s planned tapering will depend on economic data, as opposed to any perceived schedule for removing this stimulus.

Under Yellen’s guidance, the central bank is expected to gradually tighten its accommodative policies–and only after the US economy appears to be on sound footing.

Investors should also remember that the Fed could slow the pace at which it shrinks its monthly bond purchases to shore up confidence in the economy and equity markets.

The upturn in economic growth that underpins the Fed’s decision to curtail quantitative easing should more than offset headwinds related to gradually rising interest rates.

Over the past two decades, the S&P 500 and yields on US Treasury bonds both moved higher on several occasions.

Source: Bloomberg, Capitalist Times Premium

In 1998 and 1999, for example, the yield on 10-year bonds issued by the US government climbed to 6.5 percent from 4.5 percent, while the S&P 500 rallied by almost 50 percent. Robust economic growth in from 2003 to 2007 likewise produced an increase in stock prices and bond yields.

The opposite also holds true. During the 2000-03 and 2007-09 economic slowdowns, a sharp decline in US government bond yields and interest rates did little to offset vicious bear markets for stocks.

In short, the assumption that rising interest rates necessarily will translate into declines in the stock market has little basis in history. A more likely scenario: Bond yields and stock prices head higher in 2014, thanks to accelerating economic growth.

And as my colleague Roger Conrad explained at great length in What’s Rate Sensitive and What’s Not, the assumed link between dividend-paying stocks and bond yields is equally dubious.

Market history shows that many income-oriented equities are more closely correlated to the S&P 500 than the yield on the 10-year government bond.

Investors should regard the inevitable bouts of profit-taking that will occur when the Fed begins to phase out quantitative easing as an opportunity to accumulate the names in our Wealth Builders Portfolio.

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