Whew! The Washington Debt-Ceiling Can Kicked Down The Road, Should We Now Be Concerned About Fed Tapering?

With the debt-ceiling disaster narrowly averted, investors can get back to worrying about other things…

It is interesting to watch all of the hand-wringing related to fears of an eventual tapering of the Federal Reserve's controversial Quantitative Easing program. While many have questioned the effectiveness, Ben Bernanke & Co. have been buying $85 billion per month of mortgage-backed securities and longer-term Treasuries in an effort to stimulate the economy by maintaining downward pressure on longer-term interest rates, supporting mortgage markets and helping to make broader financial conditions more accommodative.

Certainly, we can't argue with the fact that the 1.6% yield on the 10-year U.S. Treasury seen in early-May provided less competition for equities than the current 2.6% level, but we have long believed that the Fed will require a significantly stronger economy (hardly a negative backdrop for corporate profits) before it actually would consider tightening monetary policy. The statement following the Federal Open Market Committee meeting on Sept. 18 said as much: "To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens." In short, the Fed is likely to remain friendly for the foreseeable future.

Despite our view that it will be quite some time before the Don't Fight the Fed Wall Street adage becomes a worry, we thought it an opportune time to review what has happened historically to stocks when Fed Funds, Long-Term Government and Inflation rates rise (and fall).

To be sure, it is also important to consider the absolute value of rates in addition to the direction they are moving as we suspect that few would view a 6% yield on the 10-year Treasury as a positive for equities in the current climate, even if the interest rate was down from 7%. After all, the current yield on the S&P 500 of 2.1% provides plenty of support for stocks against the numerous other investment vehicles available to the masses.

While past performance is never a guarantee of future performance and statisticians may find fault with the relatively small sample set as well as the tremendous dispersion between the minimum and maximum 12-month returns, we like what the historical evidence shows in regard to equities in general and value stocks (like those that we favor) in particular, should we truly be headed into a rising interest and inflation rate environment.