An important piece of news is being overlooked, or dismissed, the past couple of weeks - thanks to our nation's recent debt ceiling debacle. Janet Yellen has been named to succeed Ben Bernanke as the next Federal Reserve Chairperson. Yellen is notoriously dovish, meaning she has supported Bernanke's stance on short-term interest rates, and is likely to remain highly accommodative into 2014. This may actually be a more important development than the other recent "business" in Washington D.C., but it isn't getting nearly the same press...
Why is this important?
We all saw the stock, bond, and housing markets' reaction to the threat of rising rates during the month of June. It was May 21 that Bernanke reminded us to "drink like gentlemen" because the bar will run dry at some point. We saw the Dow and S&P 500 take a quick 6% dip, and the bond market crater as yields climbed from 1.94% to 2.54% on the 10-Year Treasury Note over the same time period. In that five-week stretch any asset class characterized as a "dividend" or "yield" instrument was somewhat indiscriminately bludgeoned:
Surveying the damage...
The FOMC Spin Cycle
Investors feared that sharply rising rates would make the investment options above less attractive when taken in comparison with "risk free" assets like US Treasury Notes. After the initial rout, we saw a remarkable snap-back recovery in all four asset classes displayed above, with the exception of Treasury Bonds, as Big Ben pacified the markets with rhetoric and rates eased. But then in July, as Larry Summers briefly took the lead as most likely to succeed - Bernanke, anyway - the 10-Yr spiked to 3.00% and our dividend-payers fell once more.
Below, you can see clearly the relief in these assets that began with Yellen's nomination on October 9th:
But perhaps the more interesting action has been occurring in the left-for-dead Emerging Markets - economies which benefit directly from lower interest rates here in the United States. We initially pointed to these opportunities back in July and September, when the argument made a lot less sense (and entry points were a little better)...
The higher the interest rates we pay on our debt, the higher rates these smaller and more economically sensitive nations must pay to attract investment in their own governments' debt. The logic is the same as companies or borrowers with lower credit ratings having to pay higher interest rates. Higher cost of funds creates additional headwinds for their growth; the converse is also true. Yellen at the helm bodes well not just for our markets which may be getting a bit extended, but also for our small, foreign counterparts whose recovery is much less mature.
Disclosure: I am long AMJ, VNQ, VWO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.