S&P 500: non-farm payroll and the ‘tapering’ narrative

by George Hatjoullis

S&P 500

The market narrative is completely focused on ‘tapering’. The word implies a steady and predictable decline in bond purchases by the Federal Reserve of the USA, as it exits the Quantitative Easing programme. The Fed exit is unlikely  to be smooth and predictable but this does not preclude the market acting as if. The market concern arises from the belief that the rally in all financial assets was largely a consequence of the Fed’s QE programme and thus, ceteris paribus, the exit will similarly deflate asset prices. As a colleague once eloquently expressed the phenomenon, a rising tide floats all boats.

Of course, one could extend the metaphor and consider why the Fed was ‘raising the tide’, as it were. The US economy was stranded on the rocks and the rising tide enabled it to sail away into deeper, less treacherous waters. Allowing the tide to go out is not really of much consequence if all the boats are safely out to sea. One could give the Fed the benefit of the doubt and recognise that the ‘tapering’ reflects the Fed’s belief that some of the boats at least are indeed safely out to sea. Tapering is not necessarily bad news.

At the moment, however, the market seems disinclined to do so and is determined to view tapering as asset negative. This has created some counterintuitive market reactions to data and events. This is quite common in market dynamics and illustrates why it is necessary to characterise the process as one of narrative construction in a relatively insular reality. It is also why many regard markets as often irrational. Markets are never irrational if viewed from within their own narrative though from the perspective of the so-called real world (i.e. non-market world) they can seem positively bonkers. Never trade or invest from a non-market perspective because, however irrational the market may seem to you, it can stay so for longer than you can remain solvent. You have been warned.

The non-farm payroll data catalysed an upward correction of the recent downward correction. It is a ‘bounce’ only if you believe the trend is still lower. The growth in non-farm payroll was marginally higher than expected. It was arguably a ‘Goldilocks’ outcome; not so hot as to accelerate tapering but hot enough to sustain a moderately positive economic outlook. Moderately good economic data now looks optimal from a market perspective. Very strong data may raise the spectre of tapering and have a counterintuitive effect on equity markets. It is interesting to note that the S&P 500 closed at 1643.8 on Friday 7 June, only 2.6% below the all time high. Moreover, it is still a couple of % above the level it was when I introduced the narrative concept (Non-farm payroll and the S&P 500: which narrative?,http://bit.ly/15S93bZ).

So what now? For all markets the summer will be quite volatile as the usual thin market conditions and low staffing levels are exacerbated by data releases that cause extreme and often, apparently, perverse reactions. From the point of view of equities this creates opportunities to buy. I am inclined to take them. From the point of view of bonds it provides opportunities to reduce holdings. Once again I am inclined to take them. Not all markets have managed to float out to sea and bonds are clearly  near the rocks. On the matter of the US dollar, the reaction has been perverse even by the terms of its narrative. It makes little sense to sell the US dollar and buy yen because the Fed is tapering. The currency moves may have more to do with events in Japan than the US. Indeed a large part of the whole market dynamic since May 23 has to do with positions within markets and technical conditions. What goes up usually comes back down some distance at some point and not necessarily in an orderly way. The trigger, you may recall, was poor output data from China and hints of tapering from Bernanke.

Looking forward it is likely that, once the summer is over, the trends established in the first 4-5 months of the year will resume. The summer should be deemed an opportunity.