Bernanke Blinks First

In a development that we thought highly likely, Federal Reserve Chairman Ben Bernanke threw more fuel on the capital markets fire yesterday. Responding to questions about monetary policy, Bernanke bluntly stated that “highly accommodative monetary policy for the foreseeable future is what’s needed in the US economy.” This is nothing new, of course. In fact, we believed all along that investors misread the initial talk of “tapering”. Yes, Bernanke did say that the Fed might begin to scale back asset purchases by the end of the year. But the tapering was conditioned upon a continued improvement in economic data. This is by no means assured.

We had also speculated in our June 26 Market Commentary that Bernanke might quickly respond to the capital markets volatility by reinforcing his commitment to monetary easing. The Chairman justified his commitment by saying that the Fed is still not delivering on its dual mandate of maximum employment and price stability. Indeed, the unemployment rate, at 7.6%, is still much higher than the Fed would like to see. Commenting on the labor market, Bernanke said that the latest unemployment reading “probably understates the weakness of the labor market.” At the same time, Bernanke said that inflation is currently running well below the Fed’s target rate (although he did opine that the slowdown in inflation may prove transitory).

The reaction to Bernanke’s comments yesterday has been dramatic. As I write, the S&P 500 is up over 1% and currently stands very close to a new all-time high. The 7% correction in stocks following the initial talk of tapering is now just a distant memory. And stocks aren’t the only assets rising today. Bonds are trading higher, gold is higher, REITs are higher, emerging market stocks are higher, and the list goes on. What about THIS inflation, Mr. Chairman? Are we to disregard the inflation in financial asset prices in our calculations of inflation? Isn’t this exactly what Greenspan did with housing prices?

The Fed is likely digging itself into an even deeper hole. Despite significant reservations about the course of monetary policy among committee participants, Bernanke has made it clear that he is in charge. The Bernanke “put” is alive and well. This refers to the notion that investors are emboldened to take on more risk because they feel that the Fed will bail them out if things go sour. If there was ever any concrete proof that one man is driving the level of asset prices, I think today is that proof. We simply think this cannot be a good thing.

And so we continue to navigate this bumpy road with a great deal of caution. High-quality and defensive companies with strong balance sheets and high-visibility earnings growth appear to be a solid alternative in this environment. Fortunately, a lot of investors have agreed with us this year.