Believe the Federal Reserve's Beige Book, Not the Headlines


Yesterday saw the release of the Federal Reserve’s ‘Beige Book’. To many observers, beige would seem to be the correct choice of color for what amounts to a series of anecdotal reports about economic activity from the various regional reserve banks; it hardly screams ‘riveting read’. In fact, the snapshot it gives of economic activity can be illuminating and, at times, entertaining. Where else could we learn, as pointed out in this piece on Slate by Matthew Yglesias, that ‘tapas and deck parties’ were more popular than fine dining in the Outer Banks this year?

Quirky stories aside, though, the overall tone of Wednesday’s release was positive, with most areas of the US reporting continued moderate growth and growing consumer confidence. This confidence is, anecdotally, leading to increased spending, making the outlook for the second half of the year positive.

It is not all rosy; with the Fed’s commentary pointing out that lending activity was generally weaker. There are of course, some obvious reasons for this such as rising interest rates, and the drop could well be temporary. One possible effect of a normalization of lending rates could be a slight loosening of the current tight lending requirements of banks. As the reward for lending increases, so a little more risk could be justified and the pace of loan origination will increase.

Overall, then, I would say that the report was positive for the economy over the next few months, but if September pans out as most believe it will, this could get lost in a sea of worry and negative headlines.

This month will bring debates on the debt ceiling and the budget. If there is one thing that I have learnt working in financial markets in five different countries, it is that you should never underestimate the ability of politicians anywhere and of any political persuasion to make a mess of an economy. That said, the usual pattern of brinkmanship and last minute compromise is the most likely outcome of these negotiations.

Conventional wisdom also says that this month will bring an announcement from the Fed about the reduction in and eventual end of QE; the dreaded ‘tapering’. If anything the positive tone of the September Beige Book has made this more likely. The resulting headlines will no doubt bring about a few days of volatility, but this is something the market has been preparing itself for over the last few months. One would expect that most of the news is already priced in.

The situation in Syria will also cause unease in markets, and any turn for the worse could see the ‘risk-off’ trades take over, once again causing volatility. It would seem, however that whatever the outcome of the Congressional vote on the President’s proposed action, a lengthy and costly military presence in the country is extremely unlikely. Increased turmoil in the Middle East could cause a spike in oil prices, but we are now accustomed to that region being in some state of flux, so the effects will, once again, likely be limited.

If the evidence of the Beige Book is to be believed, by the end of this year there should be clear indications that the pace of growth in the economy is accelerating. It certainly needs to. The 1.8% growth reported for the first half of the year, especially during a recovery, is not really growth at all. The initial shock of tax increases and sequestration should be wearing off, however, and some improvement looks a safe bet.

When lagging indicators start to show this, any ground lost to nervousness as a result of scary headlines should be made up, and then some. I expect the S&P 500 to finish the year higher than the current levels around 1650.

All of this temporary volatility will be a great opportunity for traders. For those involved in the very short term, where the market goes is irrelevant, so long as it goes somewhere. For investors, however, who have a portfolio of stocks that represent their life’s savings, September is likely to be a trying month. This could be one time when ‘sit tight’ and ‘buy and hold’ could well be sound advice.

If you are somebody who must ‘do something’ then taking some money off the table now in order to buy on any dips as the month’s events unfold makes far more sense than waiting and being squeezed out on those drops. Taking a vacation from the headlines and scary market stories for a month or so may be your best option though.

I am all for individual investors being aware and acting on their opinions to some extent, but this looks like a scenario where only bad can come from reacting. Some of the moves will be sudden and sharp, but keep in mind that markets always have a tendency to over react to news, good or bad, but ultimately the state of the economy and the profitability of companies is what counts.

Don’t be driven by panic and believe in the power of beige.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

This article appears in: Investing , Economy , US Markets

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Martin Tillier

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