Ignore ETF Knee-Jerk Reactions To Fed

December 23, 2015

Other ETF Reactions

Interest-rate-sensitive assets also exhibited strong initial reactions to the Fed announcement. The Utilities Select SPDR (XLU | A-87), the Vanguard REIT (VNQ | A-91) and mortgage REIT funds like the iShares Mortgage Real Estate Capped (REM | B-98) all generally declined at first and then climbed until the close of the market.

Ignore ETF Knee-Jerk Reactions To Fed

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Rising rates generally hurt these asset classes unless the rise is accompanied by a strengthening economy.

Of course, if we combed through Yellen's statements, we could find what specific phrases or themes likely triggered these moves. There were assertions that the Fed thinks inflation is still too low and that room remains for job growth, and statements about continuing to monitor many indicators of financial health in the economy and reacting to them accordingly. There were also words like "confident," "smoothly" and "accommodative."

Knee-Jerk Action Unimportant

Regardless of the specific causes of these short-term moves, the long-term trends will likely be driven by a multitude of factors including credit spreads, oil prices and the strength of the U.S. dollar. These factors interact in a complex way that is often hard to predict, and in a way that goes beyond the statements of any single influential group like the Fed.

We can see that from September 2015 to the December meeting, the Fed's forecast interest rate at the end of 2016 has narrowed, but as it stated in its meeting, factors like inflation, job growth, GDP growth and the overall state of the economy will be the driving forces behind what monetary policy actually gets implemented. The economy is a giant feedback loop of smaller feedback loops.

Ignore ETF Knee-Jerk Reactions To Fed

For a larger view, please click on the image above.

News Overreaction

News will always be around, and with today's information economy, we are inundated with more and more "breaking news stories" that move the markets. How we react to them is up to us. The biases that are inherent to human nature often cause collective over-/underreactions, which is one of the plausible explanations for the existence of momentum in investing.

On one hand, events like rate increases are prime examples of times when large gains and losses can be made over a short period of time by picking a side and placing a bet.

But on the flip side, since markets are at least somewhat efficient, much of information is priced in as forecasts are refined leading up to the event. It is this gradual incorporation of information that momentum models seeks to capitalize on.

We may or may not see more rate increases over the next year, but, as with this first hike, we expect that much of the contribution to long-term market trends will happen in the periods in between Fed meetings.

At the time of writing, the author's firm owned SPY and TLT, but did not own XLU, VNQ or REM, but say they are in their investment universe. GLD is not in its investment universe. Newfound Research LLC is a Boston-based quantitative asset management firm focused on rules-based, outcome-oriented investment strategies. Newfound specializes in tactical asset allocation and risk management solutions. Founded in August 2008, Newfound offers a full suite of tactical ETF managed portfolios covering global equity, U.S. small-cap equity, multi-asset income, fixed-income and liquid alternative asset classes. For more information about Newfound Research LLC, call us at 617-531-9773, visit us at www.thinknewfound.com or email us at [email protected]. For a list of relevant disclosures, click here.

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