S&P 500 and the Fed non-taper

by George Hatjoullis

S&P500The failure of the Federal Reserve to begin scaling back bond purchases was a surprise to the markets (and me). Indeed the Fed may have missed a trick here but only time will tell. It had an opportunity to remove the event of ‘taper’ from the market psyche and leave it with just ‘pace’ of taper to consider. It had already prepared the markets for the coming of tapering and the equity markets were none to concerned as witnessed by the S&P 500 trading close to the all time high just before the FOMC announcement. It could have announced the taper at a very slow and even variable rate. This would have allowed it to proceed with caution. For reasons known only to the Board, the Fed felt that caution required no taper at all, yet. What is the Fed thinking.

The constant theme of these Financial Market blogs is that the Fed knows what it is doing and that it will only initiate a taper if it thinks economic conditions warrant. Consistency requires that the blog conclude that the Fed is more concerned about the economic outlook than was apparent. It is also almost certainly concerned by the rate at which bond markets have discounted withdrawal from QE, as evidenced by higher bond yields. This has driven up mortgage rates and slowed the recovery in the housing market. Employment growth is steady but not at a pace the Fed would like and inflation is well contained. The taper has also adversely affected overseas markets and economies, notably Emerging Markets, and this may too have been a consideration. The patient is not yet ready to come off life support.

The equity markets are none too concerned about this prognosis so long as they get their fix of QE. This implies the equity market rally is not fundamentally supported but entirely liquidity based. This is analogous to the Emerging Market situation where buoyant asset values are buoyed by inward investment flows. This is not a healthy situation and not one the Fed should be perpetuating. It would have done better to initiate the taper and proceeded at a slow and variable pace if it felt cautious. By not doing so it has opened up possibilities of problems down the line. The unqualified bullish tone of the Financial Markets blogs is now tempered with concern. Maybe the Fed does not have a complete grip on the situation. Maybe the transition to a new Chairperson is complicating matters.

From the point of view of the equity investor it may be best not to dwell on fundamentals and just look at the charts. The S&P 500 has made a new high. One does not sell markets making new highs. The S&P 500 is looking a little overbought though. Moreover, it is as well to keep in mind that the Fed did indicate that the taper will begin before year-end. That is two more meetings and uncertainty will prevail as we approach these meetings. The succession is also still open and whilst dovish Janet Yellen is front-runner she may not be a done deal.