Markets Brace for Post-Fed World

At WSJ, "Despite Best Yearly Start Since 1999, Investors Spooked by Central Bank's Signals See Turbulence Ahead":

The U.S. stock market had its best start to a year since 1999, but by Friday—the halfway mark of 2013—investors had ditched their party hats and braced for the Federal Reserve to cut back on policies that helped send stocks soaring this year.

The Dow Jones Industrial Average ended the first six months of the year up 14%, but all the gains came in the first five months. The Dow fell 1.4% in June, including a 114.89 point, or 0.76%, drop on Friday to 14909.60.

The impact on financial markets from an anticipated shift in Fed policy in the second half of the year is now a matter of intense debate. In the past week, senior Fed officials have sought to reassure markets the central bank would withdraw its assistance gradually and only if the U.S. economy appeared strong enough.

But some investors said they were bracing for more tumult in the months ahead, as markets face a new, uncertain world.

"We think it is going to be a bumpy summer, a volatile summer," said Rebecca Patterson, chief investment officer at Bessemer Trust, which manages about $60 billion in New York. Ms. Patterson added that she was optimistic U.S. stocks would pull through with gains.

In June, Fed Chairman Ben Bernanke confirmed the central bank's intentions to start trimming aid this year. But he said any changes would depend on continued economic strength and be limited to gradual reductions in monthly bond-buying. Increases in the Fed's target short-term interest rates, he said, would require a return to 6.5% unemployment.

The stock market has since swung down and then up as investors tried to predict the fallout. Bond prices took an even bigger hit and yields, which rise as bond prices fall, surged.

Most Fed officials said the markets overreacted to Mr. Bernanke's news conference, but one said market volatility was a normal reaction to the prospect of a pullback by the Fed.

nvestors have become dependent on the Fed's unprecedented injections of cash into markets, including the current $85 billion-a-month bond-buying program. There is no historic experience to help predict how the unwinding of such an elaborate support system will unfold, creating uncertainty.

Jim Dunigan, chief investment officer at PNC Wealth Management, which oversees about $116 billion, compares a gradual withdrawal to movie hero Indiana Jones trying to grab a diamond from the stones of an ancient tomb without bringing the whole edifice crashing down.

"How do you withdraw the support, which has been massive?" Mr. Dunigan said. "It is hard to do. Throttling back is going to be a little tricky."

That was revealed this month, when the mere mention of a Fed pullback roiled markets across the globe. Gold ended its worst quarter since the start of modern gold trading in 1974; Brazilian stocks were down 16% and the Australian dollar tumbled more than 12%.

The U.S. bond market, which is the direct recipient of the Fed's monthly purchases, has been especially hard hit.