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What the New Federal Reserve Chairwoman Means For Stocks

US Federal Reserve

Last night, one of the coldest Arctic outbreaks in two decades in the USA brought record low temperatures to the East, the South, and the Midwest of the country, but investors’ risk appetite wasn’t frozen. America’s major market indices, the S&P 500 and the narrower Dow Jones Industrial Average, closed yesterday night’s trading session with gains of 0.61% and 0.64%, respectively.

Our own Straits Times Index (SGX: ^STI) in Singapore also gamely followed suit with a 0.6% rise to 3,140 points as of 11:45am today.

Perhaps one of the news items that stoked market gains in the US the previous night, is Monday’s United States Senate confirmation vote of Janet Yellen to succeed Ben Bernanke at the head of the US Federal Reserve, beginning on 1 Feb.

The final tally of 56-26 (some senators were not in Washington for the vote due to the inclement weather) shows tepid support for Yellen — by comparison, Bernanke’s 2010 reappointment was controversial, but it was approved with a 70-30 vote. However, that matters little now that the Fed chair is hers.

Yellen takes this post at an exceptionally delicate juncture. The appointment of a woman is a historic milestone, but the Fed hit another milestone in December as its balance sheet topped US$4 trillion in assets (more than those of giant American banks JPMorgan Chase and Wells Fargo combined), having more than quadrupled in size since the start of the financial crisis.

Yes, the central bank decided in December last year to taper its monthly bond purchases to $75 billion starting this month, but that amounts to lifting the foot from the accelerator, to use Bernanke’s own analogy — the Fed’s balance sheet will continue to expand for some time yet.

Weaning financial markets off the stimulus it has provided could prove tricky — while never failing to project confidence and authority, central bankers admit that they are in uncharted territory.

Whether or not it is accurate, many professional investors believe the Fed’s emergency measures, including three rounds of bond-buying and five-plus years of zero interest rates, have been a key driver of the spectacular bull market that has lifted the S&P 500 170% from its March 2009 low (not to mention the spectacular overvaluation in government bonds).

The Fed’s actions might also have given strong support for the Straits Times Index’s 110-plus-% gain from its own March 2009 lows. Those perceptions then foster a risk of withdrawal symptoms as the Fed takes a less interventionist role in markets.

In that context, what can we expect from Yellen? On the whole, continuity with Bernanke’s regime; we know that Yellen, as Fed vice chairwoman, has championed asset purchases and a more open communication policy. She is also reported to be willing to tolerate inflation that is moderately above the Fed’s 2% target in order to fight unemployment in the States. That is enough to have her labeled a “dove” in the financial media, though she can also be a pragmatic policymaker.

By and large, Bernanke did a first-rate job combating the crisis and its aftermath, but he leaves Yellen with some very heavy lifting. Even barring any major missteps from the Yellen Fed, it would be hard for the US to top its 2013 stock market performance after gaining close to 30% for the year.

Anyone expecting a repeat performance in the West (or anything near it) ought to take the rose-tinted glasses off; the potential for some genuine volatility, at least in the USA, in 2014 — not just the kind that goes up — looks excellent.

As for Singapore, the overall stock market was flat last year. But if American stocks start catching a cold, we shouldn’t rule out the chance of us having a sneezing fit too.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. This article was written by Alex Dumortier, CFA, and first published on fool.com. It has been edited for fool.sg