Why the Stock Market Prefers Yellen So Much for New Fed Chief

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With recent news on Federal Reserve Chairman Ben Bernanke’s possible replacements, we’re seeing even more evidence that the stock market gains really are largely dependent on the Fed’s current easy money environment. 

The stock market surged out of the gate Monday morning on news that Lawrence Summers, the then-leading candidate to replace Bernanke as the next leader of the central bank, decided to withdraw his name from consideration as new Fed chairman. This was major news for the stock market; Summers was not a favorite among stock market participants, because he was known to be a backer of tapering the monetary stimulus. Of course, this did not sit well with stock market participants, as it meant the easy money would end. 

Stocks surged on speculation that the Fed’s Vice Chairman Janet Yellen would now become the leading candidate, since it is expected that Yellen will maintain the current Fed’s gradual approach to easing. 

This surge clearly indicates how important the easy money is to the stock market. 

Whether the Fed decides to begin to rein in its bond buying when its two-day meeting ends tomorrow has now become somewhat less significant compared to who’s going to take over at the helm. The fears associated with both events may be similar, but it’s the long-term implications of what a new Fed chairman could bring to the table that is now the focus among market participants. 

Overall, the long-term implications if Yellen is appointed as the next Fed chairman will likely be a longer extension to the tapering timeline compared to what it might have been under Summers. For the stock market, it means the easy flow of money into the economic system will continue, helping to prop up the artificial U.S. economy and stock market over the longer term. 

Yet my concern is that if this does happen under Yellen, it will cause more issues and pain down the road, as interest rates will begin to ratchet higher. Companies and consumers will continue to add to their debt loads. 

That’s why I feel the Fed must begin to tighten its money flow by starting tapering tomorrow. The economy is clearly much better now than when the quantitative easing began some five years ago. So with the U.S. economy improving, it’s time to slow the flow of easy money and allow the economy to recover more on its own, lessening the market’s obvious dependence on easy money. This will be critical for the country going forward. 

I think even with the tapering, everything will be fine and if not, then the Fed could ease off on its future tapering and extend the timeline. For traders, it would mean you need to be more selective in buying stocks than what we have seen over the past four years. 

by George Leong, B.Comm.

This article was originally published at Investment Contrarians

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