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Market Commentary - 11.12.13

When Bad News is Good News and Good News is Bad News

Market movements, especially those that occur over a short term, often puzzle investors. However lately, market reactions to economic and political news appear to be completely illogical, retreating on good news and rallying on bad news. Is this a new paradigm or have investors turned completely contrarian? In April, we saw the markets slide while unemployment claims dropped to their lowest levels since 2008. We saw the opposite in September when the Federal Reserve surprised the markets by not tapering its $85 billion a month in bond purchases. On September 18th, the Fed officially downgraded its outlook for the economy and the market rallied. Officials that day reported gross domestic product growth will be in the 2.0% to 2.3% range this year, down from the 2.3% to 2.6% forecasted earlier in the year. In addition, the Fed also cut the 2014 forecast to 2.9% to 3.1% from 3.0% to 3.5%. This bad news lifted the S&P 500 to a new record high, jumping over one percent that day. The Fed’s weakened outlook on the U.S. economy prompted investor speculation that the Central Bank would delay any sort of tapering.

The “bad news rallyâ€쳌 has been perpetuated by investors who perceive weakening economic signals as a sign that the Federal Reserve will continue its stimulus spending at its current rate. These investors do not see disappointing economic signals as a sign that this will lead to another financial crisis, because the Fed, in essence, has proven willing to provide a back-stop to any sort of real market weakness. Instead, their fear is that positive economic signals may prompt the Federal Reserve to start “tapering,â€쳌 or reducing the stimulative bond purchasing program which is currently keeping interest rates low and money cheap. It is important to note that the fears are only that the Fed will reduce or “taperâ€쳌 its bond purchases. “Taperingâ€쳌 is not “tightening.â€쳌 The Fed does not plan on eliminating its bond purchases and flipping off the switch overnight. It is expected to slowly reduce its stimulus over time.

However, if the Fed backs off these stimulative measures too soon, investors fear that the market may falter. More specifically, if the Fed removes the backstop it has provided before the economy is strong enough to support continued growth, there is the risk that future growth may be stymied. Once the Fed is out of the market, however, good news will likely become good news once again.

In the long run, this anomaly will pass. In the short run, however, good news is actually creating uncertainty which is causing the markets to react counter-intuitively. To protect a portfolio in times of great uncertainty, we continue to recommend diversification as the first and most important step. Investing in asset classes that are less affected by, or which may benefit from rising interest rates or volatility, is one way to manage portfolio risk as the Fed begins to taper. Longer-term interest rates are likely going to rise, so we recommend shortening duration, or interest rate sensitivity, on the fixed income side while also overweighting corporate bonds, where the higher yield may help buffer a drop in bond prices. Non-correlated asset classes, which are asset classes that may move in opposite directions to traditional stocks and bonds, such as alternatives, can also help with diversification.

This information is compiled by Cetera Financial Group. No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.

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