Big Questions For The New Year

1/6/2014


This quarter's Q&A addresses issues that could come to a head early in the year.

Q With the stock market up so much over the last year, shouldn't I sell now, before the correction comes?

A Don't do it. Yes, a correction will come. But that's not reason enough to sell. Corrections are a part of every bull market, just as rallies are part of every bear market. Since the Dow Theory turned bullish in December 2011, the Dow Jones Industrial Average has trended steadily higher. We've seen only four corrections in which the average dipped at least 5% from a previous closing high — two this year and two in 2012 — and none featured a dip as large as 9%. 

According to Capital Research and Management, the stock market has averaged three 5% market corrections per year from 1900 through 2010. During that same period, 10% corrections occurred an average of once per year.

Partly because the bullish primary trend was reconfirmed in late December with new highs in both the Dow Industrials and Dow Transports — and partly because we are still able to assemble a diversified portfolio of reasonably valued, high-quality stocks — we are inclined to view a correction as a buying opportunity.

We'll be watching the market, and if a correction erodes our confidence, we'll advise you to reduce stock exposure.

Q Should I be worried about the Federal Reserve's plans to start tapering its bond purchases this month?

A Last month, the Federal Reserve announced the start of its long-awaited slowdown in bond purchases. But the central bankers served up the medicine with a spoonful of sugar large enough to spark a bounce in the market.

As of Dec. 25, the Federal Reserve had boosted its holdings of Treasury notes and bonds by $523 billion and added $570 billion in mortgage-backed securities for the year. This infusion of more than $1 trillion into the U.S. economy deserves at least some of the credit for the strong performance of stocks — which explains why many investors worried what would happen when the Fed changed its policy.

In May, Chairman Ben Bernanke hinted about a slowdown, or taper, of the purchases, so investors have had more than half a year to absorb the idea of tapering. And when the Fed made the announcement, it said all the right things.

The Fed cut its monthly purchase target from $85 billion to $75 billion and pledged to keep interest rates low until "well past" the time when unemployment falls to 6.5%. Talk about a soft landing.

We can expect the Fed to continue scaling back its purchases in coming months. But the first cut is generally the most painful, and in this case it didn't hurt much.

Q Should I be excited that Congress has finally got its act together and passed budget legislation?

A Sort of. The budget deal is certainly a positive, allowing Democrats to claim victory, while Republicans also insist that they've reduced the deficit without raising taxes. However, there is more to be done.

The debt ceiling, which limits the amount of money the government can borrow, was suspended in October and will take effect again Feb. 7. The U.S. Treasury can continue funding the government for a few weeks after that. But barring a rise in the ceiling, eventually the government will run out of money to pay its bills.

While some Republicans still talk tough, party leaders make public calls for unity. Investors shouldn't count their debt-ceiling hikes before the legislation passes, but most signs point to less brinksmanship than we saw last year.


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