The U.S. Federal Reserve has been very good for investors in recent years. Will new chair Janet Yellen upset the cozy relationship?
Ms. Yellen took the top job at the central bank last month after Ben Bernanke stepped down. Under Mr. Bernanke's aggressive stimulus policies, which included ultra-low interest rates and massive bond-buying programs, stocks enjoyed a bull market for nearly five years. The S&P 500 has risen more than 170 per cent from its low in 2009.
Ms. Yellen, though, is now tasked with unwinding this extraordinary stimulus, should the economy gain strength, which could make planning a retirement portfolio far more challenging for investors in the years ahead.
"Only diamonds are forever; monetary policy isn't," said Avery Shenfeld, chief economist of CIBC World Markets. "We're in the dying embers of monetary stimulus."
Ms. Yellen is widely perceived as a "dove" – that is, she tends to favour accommodative policies that will invigorate economic growth and employment over concerns about inflation. That's generally good for stocks. But with U.S. economic growth on the mend and the unemployment rate down to a five-year low of 6.6 per cent, the label no longer means a whole lot.
"I think Janet Yellen will take the properly balanced view between her two mandates [of stable prices and maximum employment]," said Peter Drake, vice-president, retirement and economic research at Fidelity Investments Canada.
The consensus is that Ms. Yellen is going to shift gears: The Fed's monthly bond-buying program, known as quantitative easing, is already winding down, and further tapering is expected, barring any significant economic setback. Then comes the guessing game as to when the Fed will raise its key interest rate, with 2015 already pencilled in.
Some observers believe the impact on long-term investors should be relatively muted, given that the stimulus withdrawal follows economic improvements.
"From a myopic perspective, you can say, 'Gosh, we want more dovishness from Yellen; it will help stocks and bonds rally,'" said Eric Lascelles, chief economist at RBC Global Asset Management. "But for people with RRSPs who are investing for the long haul, we want what's best for the economy – which, in turn, will be best for markets."
Mr. Drake agrees: "If Janet Yellen has a positive effect on equity markets, it will be from doing the things that help the U.S. economy to run well."
Mr. Lascelles believes that stocks are fairly priced, now that valuations have risen to normal levels, which means that stocks are going to follow corporate profits.
In other words, barring explosive profit growth, gains could pale next to the remarkable rallies we've seen since 2009.
As well, if Ms. Yellen moves toward a normalized monetary policy – no stimulus, and interest rates rising toward the historical norm – the shift will likely lead to a reassessment of investments that are sensitive to rising interest rates, from bonds to real estate investment trusts to dividend stocks.
"Retail investors have been justifiably nervous about having money in equities, after taking blows from the equity market over the past decade," Mr. Shenfeld said, adding that many investors are now too heavily weighted in bonds relative to stocks.
"But the tide is turning for fixed-income investments. They're not going to benefit from the capital gains associated with falling bond yields."
On the other hand, he expects that stocks with a closer connection to economic performance – such as energy stocks and the insurance sector – will gain in popularity.
And there is little expectation that Ms. Yellen will coddle the market as she directs the U.S. economy into the next phase of its recovery.
"If there were to be sharp corrections in stocks or bonds, it would certainly give the Fed pause," Mr. Lascelles said. "But in general, there is going to be less of a free ride for stocks and bonds alike."
David Berman