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Traders work on the floor of the New York Stock Exchange, March 28, 2012. (BRENDAN MCDERMID/Brendan McDermid/Reuters)
Traders work on the floor of the New York Stock Exchange, March 28, 2012. (BRENDAN MCDERMID/Brendan McDermid/Reuters)

Markets

The good news about the Fed's bad news Add to ...

Stock markets continued to tumble Wednesday following indications that the U.S. Federal Reserve Board isn’t about to embark on another round of money printing any time soon. But should investors really be pressing the panic button now that the Fed isn’t about to refill its proverbial punch bowl?

Shares had one of their biggest declines of the year, with the Dow Jones industrial average off 0.95 per cent and Toronto stocks down 1.2 per cent. But some market strategists contend the frantic selling by investors may be short sighted.

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The strategists argue that the prospects for investors would be a whole lot worse if the Fed felt it had to administer yet another shot of unconventional monetary stimulus. So far, the Fed has dispensed two rounds of “quantitative easing,” dubbed QE 1 and QE 2, the first during a scary phase of the 2008-09 financial panic and the other in 2010 when it looked like the U.S. was close to experiencing a dangerous bout of deflation.

“The lack of QE 3 [is]macro-economically positive, saying: ‘Hey, we don’t need this proverbial turbo-charged money coming in to support the economy or the markets.’ So that’s actually a sign of strength,” contends Kent Engelke, chief economic strategist at Capitol Securities Management Inc., a Richmond Virginia-based investment dealer.

The stock market decline began on Tuesday, when the Fed released minutes of its March meeting that gave no hints it was contemplating another round of quantitative easing, as some investors had hoped.

The Fed minutes suggest that the central bank figures the U.S. economy is showing enough signs of life that it doesn’t need extraordinary support from yet more money printing. In central banking lore, removing stimulus and easing off on support is often compared to taking away the punch bowl at a party before guests have the chance of getting tipsy.

Martin Barnes, chief economist at BCA Research, an independent Montreal-based investment research firm, says the Fed’s decision to refrain from indicating more easing is a good sign for the economy. He asks what investors would prefer: “A sort of lousy economy which forces the Fed to do more action or some sort of improving economy that allows the Fed to hold back?”

The Fed has indicated it will keep interest rates at near-zero levels into 2014, a monetary stance that in any other period would be viewed as exceptionally generous. Low rates and the improving business conditions in the United States suggest that stocks aren’t likely to tank as they did in 2008. “As long as the economy is growing and earnings are holding up okay, then the stock market isn’t terribly vulnerable,” Mr. Barnes says.

Part of the damage to stocks this week came from a poorly received sale of Spanish government bonds. However, if most of the jitters were a reaction to the Fed, then a big question for investors is whether an eventual rise in interest rates could derail the stock market.

On that score, Mark Chandler, fixed-income strategist at RBC Dominion Securities, says stock investors shouldn’t be overly concerned. “The economy is looking better, unemployment is going down, nominal GDP should be increasing ... you should be happy with that.”

Mr. Chandler added that improving growth often goes hand in hand with rising interest rates. “History shows that you can get ... a period when you have rising rates and still rising GDP growth [especially when interest rates are low]” he said.

On Friday, investors will get a better idea of the strength of the U.S. economy when the government releases February figures on non-farm payrolls.

Mr. Engelke says the jobs figure could provide a pleasant surprise, with as many as 240,000 private sector positions created. Such rapid employment growth, if it occurs, would further ease concerns about the state of the U.S. economy and cheer investors.

Another potential positive is the kickoff of first-quarter earnings season next week, beginning with Alcoa’s release of its profit figures on Tuesday. While Mr. Engelke admits earnings growth is slowing “we’re still going to have record profits for the S&P 500.”

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