Taper On—When Good News is Bad News

In one of its worst weeks of the past year, the S&P500 lost almost 2% last week. Volatility soared; the VIX index rose by almost 22%. That said, the absolute level of fear is nowhere near panic levels. Volume was light, but that probably had more to do with the season (the last week in August is normally a very light week) than with investor sentiment.

Technically, the S&P’s downtrend is fully intact, especially on the weekly resolution where prices look like they have a lot more room to fall from here. On the daily charts, stocks are somewhat oversold, so some sort of relief rally, or bounce, would not be out of the question. Breadth continues to weaken. The percent of stocks above their 150 day moving average is lower now than it has been for all of 2013. But as in prior multi-week pullbacks this year, the markets are approaching an area where the firm belief in the powers of the Fed has re-established the former uptrend. The next few weeks will tell us if this will happen again.

In the US economy, the news continues to be mixed. While durable goods orders plunged (far more than expected), the Dallas Fed manufacturing survey rose more than expected. Consumer confidence, in the face of high food and energy costs, strengthened. But pending home sales fell more than experts expected. Initial jobless claims have stopped improving. And both personal income and personal spending came in far lower than predicted. Folks are simply earning less money and as a result, spending less money, especially as their ability to borrow (and go into debt) diminishes.

So if the US economic data isn’t imploding, why are equity and other risk markets not happy? The answer it seems is all tied to the Fed’s QE program and the prospects of tapering it.

Over the last couple of years, it appears that stock markets have become so conditioned to more and more monetary easing (as the Fed prints, the markets rejoice) based on weak economic data, that any news that leads to the opposite condition (better economic data means that the Fed has less reason to print) is being greeted with fear and lower prices.

And setting aside other factors, such as the tensions in Syria, that’s exactly what’s been happening in August. US economic data is not getting worse. On some levels, it’s firming. That’s good news.

But that means it’s bad news for the markets. The Fed has more reason to proceed with a tapering of its latest QE program. And this is spooking the markets.

So expect a growing possibility of a bigger sell-off this fall, as the ‘taper’ gets announced formally.

After that, ironically, if markets decline a lot, and if this feeds back, negatively, into the real economy, expect the Fed to resume its prior QE program, or even escalate it. Markets would probably jump for joy, but as always, Main Street and the real economy will only limp along, on life-support, never gaining true escape velocity.

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