Averages Pause Amid Interest-Rate Worries


After reaching fresh all-time highs in mid-November, the major averages have dipped amid valuation concerns and worries regarding Federal Reserve policy. While a more substantial market pullback would not be surprising, we continue to favor stocks over bonds and cash for those looking out at least 12 months. Our buy lists have 95% to 96% in stocks, with the remainder in a short-term bond fund.

Fed minutes lift yields

Minutes from the Fed's October meeting indicate that the central bank could cut its $85 billion in monthly bond purchases in "coming months," and many expect the Fed to begin tapering its bond-buying in December if near-term economic reports remain solid. Yields on 10-year Treasury bonds jumped to a two-month high near 2.8% on the release of the October minutes, putting pressure on such rate-sensitive sectors as utilities and telecom. Gold prices slumped to a fresh four-month low, partly because of mild inflation numbers.

Earnings yields (earnings/price ratios) on U.S. stocks remain quite attractive relative to bond yields. So, a modest increase in bond yields is unlikely to prove fatal for the bull market, especially if yields rise on signs of improvement in the economy.

The risk is another sharp jump in yields like that seen from May to September, which apparently took the Fed by surprise. A breakout in the 10-year bond yield above 3.0%, where it peaked in September, is likely to put interest-rate worries back on the front burner.

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