CASHING IN ON MARKET´S FED TANTRUM / THE WALL STREET JOURNAL

Cashing In on Markets’ Fed Tantrum

Markets took a dovish Fed decision badly. Investors should keep some powder dry.

By Richard Barley

  Chairwoman Janet Yellen has cited concerns about China and emerging markets as playing a part in the Federal Reserve’s decision last week to keep rates unchanged. Photo: Brendan Smialowski/Agence France-Presse/Getty Images


The Fed has left investors feeling dazed and confused. Taking a more cautious tack looks like a good tactic in the face of that.

Thursday’s message from U.S. Federal Reserve Chairwoman Janet Yellen was one that investors have heard before: Interest rates will remain lower for a while longer yet. In the past, that has served to stoke financial risk-taking, sending investors searching for yield and into stocks.

Friday’s reaction was very different. European stocks sank, with the German DAX index down 3%. U.S. stocks fell, too. Credit markets sagged. Only government-bond markets behaved as expected, with yields falling. Risk-taking was notable by its absence.

One worry is global growth. Indeed, Ms. Yellen labeled concerns about China and emerging markets as playing a part in the Fed’s thinking, while acknowledging a domestic case for a rate increase could be built. It isn’t clear how quickly these concerns might be assuaged, as many emerging-market countries face fundamental challenges in changing economic models.

And the importance of such markets also reflects that the world has changed since the Fed last embarked on a rate cycle. In 2004, China accounted for 9.1% of world gross domestic product on a purchasing-power-parity basis, according to the International Monetary Fund; in 2015 it will account for 16.9%. Emerging markets in aggregate now account for 57% of world GDP, versus 46% in 2004.

For some, the fear is that the maintenance of zero interest rates may lead to further misallocation of capital. Already merger-and-acquisition activity has boomed. Companies may be encouraged to engage in further financial engineering to boost shareholder returns as debt remains historically cheap.

And overall, central banks’ ability to suppress volatility is diminishing. In recent years, quantitative easing and forward guidance acted as painkillers for markets. But data dependency is the new buzz phrase for central banks like the Fed looking to raise rates. Higher volatility in markets seems like a likely outcome. That should in the long run be a good thing, as investors shouldn’t rely on central banks to shield them from market moves. But the transition is a bumpy one.

The message is that investors who have built up cash balances—which rose to 5.5% in Bank of America Merrill Lynch’s September global fund manager survey, the highest level since just after Lehman Brothers’ collapse—shouldn’t rush to spend them.

The opportunity cost of holding cash has fallen, and choppy markets will throw up the chance to buy mispriced assets. Keeping some powder dry makes sense.