Markets and the Fed’s Taper

The S&P500 dropped 1 percent last week on light volume. Although this was the third drop in the last four weeks, by no means were investors rushing to get out. Volatility rose by 13% but once again, there was no panic in the markets—the VIX is still, at 17, much closer to levels associated with complacency than levels associated with fear.

Despite the modest pullback over the last four weeks, the S&P500 is still, technically, stretched towards the upper end of its price channel. It never came close to its 200 day moving average, and it never even closed below its 50 day moving average. So the uptrend on the daily and for sure on the weekly charts is still in effect. Internally, the breadth of the advance has weakened somewhat. The percent of stocks above their 50 day moving average has dropped from over 90% to about 60% over the last four weeks. But that’s still fairly strong. And the new highs minus new lows has dropped, but it’s still positive. All in all, the US stock market has not yet broken its bullish surge higher.

As Wall Street continues to cheer, the US economy, or Main Street, continues to struggle. New job openings, as measured in the JOLTS survey, fell instead of rising as expected. Retail sales, when excluding the volatile and government-supported auto sector, rose less than expected. Initial jobless claims came in slightly better than expected. Producer prices were hotter than the consensus forecast; this means that pressure on corporate profits is growing. The big number of the week was industrial production and it disappointed. Instead of growing at 0.2%, it came in at zero growth. Production and capacity utilization in America are stagnating. Finally, consumer sentiment was much weaker than expected.

So if US economic data, week in and week out, disappoint and confound the expert economists who’ve been calling for an organic ‘recovery’ for over three years now (to no avail), why does the US stock market, and virtually all other investment markets, continue to shine?

Why is bad news on Main Street translate into good news for Wall Street?

It’s all about QE and the ‘taper’. Everyone seems to believe that the Federal Reserve will not begin to pare back, or taper, its $85 billion per month printing program if US economic data continue to come in below expectations.

And this means that investors and speculators continue to stay in the game, in the markets, looking for additional returns—on their stocks, their junk bonds, their investment grade bonds, etc.

Wall Street is convinced that weakness on Main Street will prevent the Fed from tapering its QE program, and thus, there’s no reason to sell……just yet. On the contrary, everyone believes that all dips should be bought.

Wall Street is convinced that when the time comes—when US economic data actually does begin to shine, and when the Fed actually decided to taper its QE—it will THEN sell its stocks, its bonds, its real estate—-perfectly timing the market and locking in the magnificent gains provided courtesy of the Fed up until that time.

Since the music is still playing, we’ll keep dancing. We’ll get out when the music stops.

Wall Street is certainly not worried about this simple, but crucial, detail. When millions and millions of stock owners ALL notice that the music is stopping, and they ALL decide that it’s time to get out, WHO will they ALL sell to?

But that’ll be a problem for another day. Right now, it’s still party time!



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