Investors should celebrate that the Federal Reserve is finally getting out of the investment business. Why? Because it provides some certainty.
"The announcement of tapering turned an uncertainty into a certainty. That is always good news for equity investors," said James M. Meyer, who writes the note to clients for the Boenning & Scattergood investment firm in West Conshohocken.
"When investors are unsure what to expect, they tend to expect the worst," said Ed Kohlhepp of Kohlhepp Advisors in Doylestown. "Investors are right to cheer now as the biggest, clumsiest bond buyer in history starts cautiously easing away from the auction table."
Starting in January, the Fed will taper its bond buying to $35 billion in mortgage-backed securities each month (versus $40 billion previously) and $40 billion in Treasuries (versus $45 billion), citing better job markets and the economy as the reason. At the same time, the Fed will leave key interest rates unchanged until after unemployment falls below 6.5 percent and inflation rises to 2 percent.
But for bond investors, the central bank's decision to taper is more complicated.
Federal Reserve Board economists believe the U.S. recovery is self-sustaining, and the central bank has managed to separate tapering from interest-rate change in the minds of investors. So where are rates going?
"Almost everyone I talk to is wondering about interest rates," said J.R. Rieger, vice president of fixed-income indices at the S&P Dow Jones Index. "Even my taxi driver told me not to buy bonds!"
Why? Because as interest rates rise, bond prices fall, making them less attractive.
Big mutual-fund firms are complicating the bond markets because they are forced sellers, due to retail investors' cashing out.
"The flight from bonds has forced mutual funds to sell. That means when Fidelity sells, it has to sell its bonds, and Vanguard is not able to buy because they have to sell bonds as well," said David Kotok of Cumberland Advisors in Vineland.
That creates bargains in the bond space.
"We resist this notion that the bond market is headed for an absolute debacle in 2014. We particularly favor the tax-free municipal bond," Kotok said. "When a high-grade, long-term, tax-free yield of 5 percent is obtainable in a very low-inflation environment, investors who run from bonds and liquidate will look back, regret the opportunities they missed, and wonder why they did it."