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FED,Tapering & Your Portfolio - An Overview

|Includes:SPDR Dow Jones Industrial Average ETF (DIA), QQQ, SPY

In the upcoming days & weeks we will be inundated with news regarding the Fed and the possibility that they will initiate "tapering" of their current bond buying program.

I'll get right to the point. There are always numerous risks threats & concerns regarding corporate profitability and stock prices, but the start of a long process of Fed "tapering" is not one of them.

At the moment, it means getting some perspective on interest rates and the Fed. At some point, high interest rates might be a negative for stocks -- but not yet. However, we have to be mindful of the associated knee jerk reaction from panicked investors that will probably ensue.

All of the QE critics have trumpeted an argument that clearly cannot be defended. Interest rates have RISEN during QE. It's clearly plain to see that it's NOT "all about the Fed".

The Fed does not control rates at the long end of the market. Sure they are a huge player here, but it's less than 1% of the market. There are numerous other forces at work in this equation. All of these are summarily dismissed time & time again as the critics have become 'Fed Obsessed"

I always try to form opinion as it relates to the 'source". It is important for all investors to keep in mind as they form their own opinions on the markets.

Those who have been continually wrong about the economy, the market, and the fundamentals, attribute everything to the Fed. They do this because the slogans are easy and they sound, oh so persuasive to everyone. However ,there is little or no analytical content, no supporting data. As I have stated in many comments here on SA they use the Fed as a cover up and blame Bernanke for their own mistakes.

Here are just a few examples of the errors & false claims from these so called pundits who have gotten the story wrong. Remember when higher oil prices, corn prices, and gold prices were all supposed to be a function of the Fed? What happened to those claims? Seen Gold lately?, it's down 20% this year !

What about the idea that the Fed was debasing the currency? Look at the chart of the dollar lately ?

Runaway inflation? Another incorrect assumption , Now they cite the government conspiracies in CPI calculations to support their case.

I do know one thing, if I am seeking advice about the Fed and investment related results, why would I look to those who have been wrong for many years? Answer : I don't !, and recommend -- neither should you.

As interest rates move slowly higher, the economy has become stronger. Bears choose to howl that there is no improvement, this in the face of obvious facts that clearly shows otherwise. It has improved since the financial crisis moments and that is all the market is concentrating on. Markets don't trade on absolutes they trade on "change". They have clearly signaled that with this latest bull rally in equities. Something the bears have totally ignored and therefore have missed this latest upswing.

The present low interest rate environment we are in has created an exaggerated risk premium for stocks and an artificially depressed P/E multiple. Now, if the economy had any respect, the multiple might be 20 on forward earnings which is not uncommon at all. Many are of the opinion that a 20 multiple would still be a big discount to a 4% 10-year treasury note. Fear & uncertainty is still pervasive. Just look at how many loathe this market. So the current disrespect for the economic conditions is somewhat understandable.

As rate normalization starts to take place it will be good news for corporate profits - especially for those in the following sectors, cyclicals, financials, technology, and consumer discretionary.

As the investment world returns to a more normal state, we can expect to see the following:

A return to trend GDP - 3%+ or even better. A stronger employment picture and of course higher interest rates perhaps a 4% 10 year.

This will spur stronger total profits and revenues, & all are intertwined to reduced budget deficits, especially as a percentage of GDP.

Along with that I envision higher market multiples - because of the relationship between stock multiples and bond rates.

All of these conditions will come under scrutiny by the "bear crowd", but lets not forget they have had it wrong to date.. So, I'll take their argument for what its worth..

We are currently entering a tipping point phase in the markets as they adjust to the new climate.

Stock prices and interest rates are on a path that will lead us to take a winding but lucrative path. This should be your guide to choosing investments. The implication is that stocks will get higher multiples as we move forward as confidence further improves. This is not a guess or speculation, but a conclusion based upon the data presented.

If the market were to embrace this traditional relationship, the forward earnings multiple would be in the 20's. Take $115-$120 in estimated S & P '14 earnings and apply a 17 multiple .. That equates to S & P 1955 as the low end of the range. This example is used to illustrate the "potential" for much higher prices as this story plays out. How long it takes is anybody's guess, but the path of least resistance for equity prices is higher and can be much higher than they are today.

We wont get there overnight, and we have learned that nothing goes up in a straight line ! As we move along to higher stock prices we will see corrections along the way , some may be quite significant as 10-15% or more are the 'norm" These events are very difficult to predict , many just come 'out of the blue" & usually have no bearing on any fundamentals. You can go back and look at my attempt to try & predict a long awaited correction this past year. That is why timing the market is so difficult and if you have followed the advice here you have been invested in equities , harvesting profits along the way that will be put to work when the inevitable pause takes place. Trying to be "all in or all out" is to be on a road to frustration and potential failure.

As mentioned earlier , we want to concentrate on Low PE stocks in the cyclical, technology, financial and consumer discretionary sectors

Along that winding road , Bonds, and Utility stocks are just two areas that will come under severe pressure. We have already witnessed the first wave of that selling. Look at the REIT sector in the last week or so. We will see an overreaction to the downside in these sectors as the market sorts out this new scenario. Typically when the selling is overdone opportunity abounds. I will have follow up commentary on stocks that may become attractive for purchase.

Please keep in mind that we will be bombarded with "fear talk" regarding rising interest rates. The "talking heads" ,pundits will embellish headlines especially if we see a corrective phase take hold in the market. Stay focused on what really matters , corporate earnings, PE Ratios, Free cash flow metrics and the like, to avoid being swayed & whipsawed by the crowd that has gotten it "wrong".

My next commentary will cite some points on how I believe the tapering will take place and I will leave room for possible scenarios that could negatively impact my views.

Stay Tuned

Stocks: DIA, SPY, QQQ