NEW YORK (
) -- An important piece of news seems to have been overlooked, or even ignored, in the past month, thanks to our nation's debt ceiling debacle and Affordable Care Act bickering.
We all know that Janet Yellen has been nominated to succeed Ben Bernanke as the next
chairperson. Yellen is notoriously dovish, meaning she has supported Bernanke's stance on short-term interest rates and is likely to remain highly accommodative into 2014. This isn't news either, but digging a little deeper, we can see that the continuation of Bernanke's policies may have farther-reaching effects than it appears at first glance.
Why is this so important?
We all saw the stock, bond and housing markets' reaction to the perceived threat of rising rates during the month of June. After all, on May 21 Bernanke reminded us to "drink like gentlemen," because the bar will inevitably run dry at some point. We saw the
take a quick 6% dip and the bond market crater as yields climbed from 1.94% to 2.54% on the 10-year Treasury Note over that five-week stretch. Over that period, any asset class characterized as a "dividend" or "yield" instrument was somewhat indiscriminately bludgeoned:
Surveying the damage pictured above:
(-7.53%) - Utilities, IDU
(-7.63%) - Long-term U.S. Treasury Bonds, TLT
(-9.25%) - Master Limited Partnerships, AMJ
(-15.96%) - REITs, VNQ
The FOMC Spin Cycle
Investors feared that sharply rising rates would make the investment options above less attractive in comparison to "risk free" assets like U.S. Treasury bonds. After the initial rout, we saw a remarkable snap-back recovery in all four asset classes displayed above (with the exception of Treasury bonds) as Big Ben pacified the markets with rhetoric and rates eased.
Then in July, as speculation centered around Larry Summers as most likely to succeed Bernanke, the 10-year spiked to 3.00% and our dividend-payers fell once more. The key ingredient for these asset classes isn't as simple as "low rates good, rising rates bad." Truly, it's the spread between the yields being kicked off by these investments, taken in comparison with those of the risk-free Treasury.
With Yellen's nomination on Oct. 9, these assets saw sweet relief. In the three weeks since, we have seen a remarkable recovery in the assets that were so hated in the three months prior:
Far-Reaching Effects of QE
Perhaps the more interesting action has been occurring in the left-for-dead Emerging Markets -- economies that benefit directly from lower interest rates here in the United States. We initially pointed to these opportunities back in July and September, when the argument made a lot less sense (but entry points were quite a bit better).
+12.47% -- S&P 500
+16.11% -- Emerging Markets, VWO
The higher the interest rates the United States pays on its debt, the higher rates these smaller and more economically sensitive nations must pay to attract investment in their own governments' debt. The logic is the same as when companies or borrowers with lower credit ratings have to pay higher interest rates to secure loans. Higher cost of funds creates additional headwinds for their growth; the converse is also true.
What if I'm wrong, though? What if Rand Paul filibusters to block Yellen's nomination, or Yellen has a change of heart after accepting her nomination? If rates spike higher again, aren't we going to see the same pain that we endured for the entire month of June? Maybe.
The trouble with that argument is you're not just fighting the Fed, whose primary objective is to see solid improvements in the labor market (specifically, an unemployment rate of 6.5%). You are also fighting retirees, endowments, pension funds, foreign governments and mutual funds who may be infinitely more interested in securing 3% on their fixed income portfolios than they are at 2%. Any increased appetite for our government's debt puts downward pressure on the interest rates we must pay to attract investment. Everything is relative.
Yellen at the helm bodes well not just for our markets which may be getting a bit extended, but also for our small, foreign counterparts whose recovery is much less mature.
As the world's largest economy, the scope of our policies cannot be measured simply by our unemployment rate and GDP growth. In fact, our unemployment and GDP growth depends more on the health of other economies than it ever has before.
At the time of publication the author was long AMJ, VNQ & VWO.
-- Written by Adam B. Scott
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Adam B. Scott co-founded Argyle Capital Partners with nearly a decade of experience in wealth management at Morgan Stanley and UBS in Beverly Hills, Calif. He uses his extensive market knowledge, unique perspective and macro-level analysis to implement customized solutions for high net worth private clients. Adam is a graduate of Tufts University where he studied Mechanical Engineering and Finance, captained the Men's Varsity Tennis Team and served on the Senior Leadership Corps. Adam is still an avid tennis player and skier, and volunteers his free time to the Fulfillment Fund, the Tufts Alumni Association and coaching local youth sports.