The Fed’s Balancing Act, the Markets and Your Portfolio

Central bankers are dancing on a tightrope as they try to steer us toward higher interest rates and less monetary stimulus without triggering a downturn.

Beginning in 2009, central banks made the markets safe for risk-takers by flooding the globe with money.

The results were a very long period of modest economic growth and one of the highest-returning and longest bull markets for U.S. stocks and bonds.

Other investments also did well.

But we passed a turning point many investors still haven’t recognized.

The United States was the fi st to start closing the monetary spigot in 2014 when it ended quantitative easing. China followed. More recently, the heads of the European Central Bank and Bank of England said they would consider tight- ening monetary policy in the near future.

I’ve said for several years that the biggest risk for investors is that the Fed, and other central banks, might tighten too much, too fast.

After markets started to reflect fears that might be happening in June and July, Fed Chair Janet Yellen made it clear central bankers realize this risk and don’t want to make that mistake. In testimony to congressional committees in July, Yellen said that while the Fed plans to continue raising rates, the rate increases will be gradual, spread over several years, and were unlikely to reach the highs of previous cycles. The Fed also will adjust its plans in response to economic data.

That means for an indefinite time, the Fed and other central banks will support the economy and, indirectly, the markets.

Most of the global economy has achieved sustainable growth. The central bankers want that to continue but also want to raise interest rates.

Yellen’s remarks also made clear the central bankers know what a difficult balancing act that will be.

There are no warning signs of a bear market or recession in the United States in the more reliable indicators.

The economy is sustaining its growth, and household demand continues growing, though erratically. The job market is strong, and wages are increasing slowly but steadily. Higher home and stock prices also increase consumer confidence. There’s also no reason for the central banks to accelerate their tightening schedule.

While most investors are complacent and enjoying the low volatility of the markets, this is a good time to focus on managing risk, having a margin of safety and keeping a balanced portfolio.

I continue to see greater opportuni- ties outside of U.S. markets. Money continues to flow into the assets we identified in early 2016 as having better potential and lower risk: emerging market stocks, emerging market bonds and European stocks.

This trend should continue. These investments went through a bear market in the years before 2016 while U.S. stocks had a strong rally. Today, U.S. stock prices already refl ct strong earn- ings growth expected over the next year or two. European and Latin American stocks, on the other hand, don’t reflect the recovery that’s begun or the potential for higher earnings growth. Their valuations have lagged developments and continue to do so.

It also is possible we’ll see another rally in commodities.

You earn safe, solid returns by focusing on the factors that matter to the markets. Don’t focus on the political controversies and scandals in Washington. Don’t listen to the talking heads who overreact to each earnings report or speech from a Fed member.

With monetary policy being throt- tled back, don’t expect in the next few years a repeat of the returns U.S. stocks earned in the last eight years. But you’ll continue to do well by focusing on risk management and the factors that matter to the markets.