Yellen's Lullaby for Investors and Traders

07/12/2017 6:37 pm EST

Focus: STOCKS

David Fabian

Managing Partner, FMD Capital Management

Just like that, a few dovish words flow from the Fed Chairwoman ring out like a soothing lullaby, and stocks have rallied back to their most recent highs, notes David Fabian, money manager and editor of The Flexible Growth & Income Report.

As if it was news, Janet Yellen today coddled the market by promising to keep interest rate hikes gradual and reassured investors that it won’t be long before we reach a “neutral rate,” which is code for a holding pattern.

The problem with neutral rate assumptions is that it comes as a new normal, after such accommodative action. Although the removal of QE and subsequent rate hikes are measured to have a tightening effect of 400-450 basis points, it’s unclear if the Fed would have enough room to maneuver with interest rate cuts alone to stem the next recession.

While that may be years, or even a decade away, the concern is that asset price bubbles or inflation could morph into another crisis the Fed may not have the foresight to subdue. 

While both stocks and bonds are appreciating the reassurance in today’s session, we think it comes at a time when asset prices are stretched on a relative basis. 

The economy is growing slowly, continuing to add jobs, and household consumption is humming right along, evidenced by Amazon (AMZN) Prime Day reaching record-setting numbers. 

The conundrum is: where do investors go from here? Looking at the markets, one of the most important charts to keep an eye on right now is the CBOE Volatility Index (VIX), which is the market’s measure of volatility. Examining the last two years, a cross section in time where the market has posted excellent returns, the VIX continues to fall to new lows. 

chart

Volatility is now likely to be the best opportunity for investors in the short to intermediate-term relative to other investments. While we are not prepared to participate, primarily due to the lack of attractive investment vehicles, and the erratic price swings, we think this chart is truly representative of a trend begging for reversal.

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