Investors are anxiously awaiting the Fed's decision later this month on tapering its asset purchase program. If the Fed does announce a pullback on its monetary stimulus that has been pumping $85 billion of liquidity into the economy monthly, it is likely to impact the stock markets negatively. The resulting rise in interest rates, if significant enough, could hurt the fledgling housing recovery which is critical to overall economic recovery. Despite the news, opinions and anxiety over the Fed's next step, here is why I am not sweating over being invested in common stocks right now.
1. Mixed Economic Data: While there have been many signals of improving economic growth , like GDP growth of 2.5% in the second quarter, continued firming of housing prices, manufacturing and construction spending expansion, etc., there are still other economic indicators that show weakness. There are high expectations from the August payroll report to be released on Friday, but so far labor market recovery has been slow. Income growth and consumer spending have also been sluggish and the unemployment rate (while declining) is still at 7.4%. Even if the employment report on Friday turns out to be better than expected, I think there are still enough mixed signals in the economy to make the Fed extremely careful in any action it takes. So I would expect any tapering of the QE program to be slow and methodical - minimizing any major dampening of the recovery in place. Also I read the expansionary policies the Fed has undertaken so far as indication that if the recovery was to start decelerating it would move quickly to prevent a downward spiral.
2. Bubbles: An overheated real estate market was at the center of the recession we are still recovering from. Even as we emerge from that shadow there had been an over excitement of sorts around housing recovery in recent months. Housing prices had been rising with talk of a seller's market making a comeback in many parts of the country. The volatile multi-family market also saw some bubble like activity. The Fed's indications of a possible pullback of its stimulus and the ensuing interest rate rise can be viewed as a mechanism to curb such potential overheating, rather than putting a brake on housing recovery.
3. Underlying Strength: The stock market may feel some short term pain from a Fed tapering but for long term investors there is a silver lining in this cloud. The Fed would base such a decision on the economic data that is being reported and only a strong enough signal of growth from the labor market and income stats would persuade such action. So an overall improving picture of the economy is better for investors in the long run even if they have to endure some volatility in the near term.