Feb 14, 2014 02:51PM ● Published by Cate Reynolds
By Gregory S. Ostrowski, Certified Financial Planner®
These days, it’s nearly impossible to pick up a newspaper or turn on the television without being confronted with major changes in today’s world. These outside influences can agitate markets and exert significant effects on your portfolio. Though investment clients are often encouraged to stay focused on their long-term strategies during periods of market volatility or decline, that doesn’t mean sitting back and passively accepting whatever happens. One of the benefits of an active management strategy is that you and your portfolio manager can work to identify and leverage opportunities during such volatility. That said, here are a few of the outside influences we expect may move markets in the months to come.
As the economic recovery has gained steam, interest rates have crept upward as market participants prepared for life without the Federal Reserve’s quantitative easing programs. While higher interest rates are often seen as a sign of an improving economy, they can have ripple effects across the economy as credit becomes more expensive. These effects are already visible in rising mortgage rates, which are acting as a headwind in the housing sector. Since mid-2013, mortgage interest rates have increased steadily and they don’t look like they’re stopping any time soon. Soon: one, mortgage applications have been falling in tandem with rising interest rates, as refinances fall off; and, two, the housing recovery may be threatened by these higher rates as rising mortgage rates crowd out homebuyers. On the other hand, the housing sector has benefited from a tight supply of homes, meaning that demand may remain high, even as rates rise.
Bond investors should also be aware of the effects that higher interest rates can have on their fixed income portfolios. When interest rates rise, bond prices typically fall, all other things being equal, as investors prefer to purchase new bonds at the higher interest rates. While this doesn’t affect bondholders who intend to keep their bonds until maturity, it can affect the market value of bonds and bond mutual fund portfolios.
The Federal Reserve
Uncertainty around Fed actions has had an enormous impact on short-term market movements. The end of the Fed’s monthly $85 billion quantitative easing programs and a return to “normal” monetary policy has occupied headlines for months and alternately boosted and depressed markets. It’s hard to separate the effect of the Fed’s quantitative easing programs from the natural economic cycle, but we can be pretty sure that they boosted GDP growth and encouraged the economic recovery. Fortunately, the economy is on a solid footing and the removal of that extra support shouldn’t affect economic activity too much.
The stock market is a different animal. Though markets tend to mirror economic trends over the long term, they can behave very differently in the short term. An example of this is how investors have reacted badly to positive economic news in previous months out of fear of how the Fed would react. However, Ben Bernanke, the previous Federal Reserve chairman, did a good job of telegraphing the Fed’s play and we believe that tapering is priced into market expectations. Ultimately, while the lack of continuing Fed support may cause some short-term market jitters, we don’t expect tapering to affect market returns in the long term. We believe this is the case because tapering is essentially a vote of confidence by the Fed that the economy is doing well, and we expect markets to reflect that in the months to come.
The Affordable Care Act
Perhaps no issue has been as contentious as the rollout of the Affordable Care Act and state and federal health insurance exchanges. While it’s hard to know what the long-term results of such far-reaching health care reforms are going to be for Americans, we can take a broad look at how the new regulations will affect certain sectors of the economy.
Potential winners: The health care sector may be undergoing major changes due to provisions of the ACA, but hospitals and physicians stand to gain millions of newly insured patients, as well as revenue increases from new coverage of services. Insurance companies are also taking the changes in stride and several major insurers anticipate a rosy 2014.
Potential losers: It’s hard to wade through the political quagmire and find actual data, but we can see that medical device makers may see their margins squeezed by the ACA. Starting this year, medical device makers face a 2.3 percent tax on their products, as well as a health care system under pressure to control costs, meaning they may see both revenue and profits fall. We’ll be keeping an eye on this sector to see how the continuing rollout of the ACA affects it and creates new investment opportunities.
One of the major unknowns is how consumer spending will be affected by the cost of insurance premiums for Americans who had previously paid less for their health insurance (or gone without.) Since consumer spending accounts for approximately 70 percent of economic activity, a decline could take a major bite out of GDP growth this year. The ACA also affects businesses, large and small, who may be required to provide insurance that complies with the new regulations. Currently, it’s hard to know whether the benefits in cheaper insurance and tax credits outweigh the costs of complex regulations and overhead costs. Whatever happens, some companies will benefit and some will not. One thing we know for certain is that the full effects of health care reform aren’t visible yet and won’t be for some years yet.
Keeping It in Perspective
It’s impossible to predict the direction of future market movements or know in advance precisely how outside events will affect your portfolio. Ultimately, we don’t believe that the macro events we’ve discussed here will have lingering, long-term effects on markets. While it can be difficult to hold the course during periods of volatility and market declines, we strongly recommend focusing on your longterm goals and building a financial strategy that is designed around you and your needs. Discipline is critical to any investment strategy, but so is adaptability. Successful longterm investors know how to remain flexible and adjust to shifting market environments. Rather than sit on the sidelines, portfolio managers seek out new opportunities and stay nimble enough to take advantage of future surprises.