Dow 22,000 is Great, But Major Fed Action Looms

Everybody is pumped about the Dow Jones Industrial Average hitting the 22,000 mark for the first time on Wednesday, but Amaury Conti, the Chief Strategist at San Antonio's Sendero Wealth Management says there is a major challenge for investors right around the corner which will definitely impact the face of trading for the coming several years, News Radio 1200 WOAI reports.

He says the Federal Reserve Board has indicated that September will spell the start of its effort in 'liquidity contraction,' essentially selling the $2 trillion in mortgage backed securities, fixed income assets, and other instruments it purchased during two rounds of 'quantative easing' as a way to spur the markets and climb out of the Great Recession of 2008.

"The impact of reducing that liquidity, not just on the equity markets, but its impact on bonds and loans and everything," Conti said.  "We believe it is going to have an impact."

Conti says the impact will take several forms.

First of all, the Fed has been first the biggest buyer, and for the last several years the biggest holder, of financial instruments in the nation.  The fact that the Fed has locked up so many financial assets means investors have been essentially required to turn to equities.  Now, if the Fed is selling, that means somebody will be buying, and those buyers will be the same buyers who have been devouring stocks during the bull market of the last four years.

Conti says another impact will be that, in order to incentivize buyers of its instruments, interest rates will necessarily rise to offset the attractiveness of stocks over the last several years.  He says higher interest rates will mean higher loan rates, higher mortgage rates, higher credit card rates, and that will ripple strongly through the economy.

"What does that mean going forward, where interest rates could potentially go, not just a little bit higher, but potentially a lot higher, especially because they are so low."

He says a rising interest rate environment will be new for many investors and investment advisers.  Since the last time we saw a significant run up of interest rates was the late 1980s, many of today's investors have only existed in eras of falling or stable rates.

He says even though it calls to mind Alan Greenspan's famous quote about how the role of the central bank is to 'remove the punch bowl just as the party gets started,' it is critical that the Fed unravel its purchases and set the economy back to equilibrium.

"We need to get the balance sheet overall back to where it was, or at least closer to where it was, before 2008," he said.

Conti says in addition to the Fed, central banks around the world are also planning to unravel the purchases they made during and immediately after the Great Recession, if for no other reason than to make sure quantitive easing is again a tool they can use when the next recession arrives.

But Conti says the result will be trillions of dollars in investment devices being dropped onto the market, probably over the course of the next several years.He says that will definiately affect the forces which propelled the Dow to its 22,000 milestone.

But Conti says market fundamentals, from sales to profits, are generally strong today, so the Fed's actions don't necessarily mean the punchbowl will be completely drained.  But he says this coming event is something investors need to consider in rebalancing portfolios going forward.

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