In a week of ups and downs, the S&P500 closed 1.3% higher on higher volume, But the highest volume day was Friday, the day that the S&P sold off the hardest. Volatility dipped again, this time to the ultra-complacent levels last seen during the summer months.
The major catalyst for the week’s advance was the Federal Reserve’s announcement that it would not taper its monthly $85 billion QE program that is rapidly ballooning its balance sheet to $4 trillion, up from a mere $850 billion in early 2008. Markets were shocked because it was widely expected that the Fed would at cut back its credit creation by a minor $10 billion to $15 billion. With the exception of the US dollar, almost every other asset class jumped on the news—Treasuries, investment grade credit, high yield, equities, metals, and other commodities.
At the same time, US macro news continues to be disappointing. The Empire State manufacturing survey missed expectations badly. Industrial production also missed. Housing starts disappointed, with a big miss. Initial jobless claims have beaten estimates for two straight weeks, but as the BLS has warned, these two reports are tainted by several serious software glitches in key reporting states such as California. On the bright side, existing home sales were stronger than expected. The Philly Fed survey beat expectations, and so did the leading indicators index.
Technically, the S&P500 is becoming very oversold on the daily charts. Several short term breadth indicators, such as the McClellan Oscillator are pointing to the high probability of at least a temporary pullback in stock prices. On the weekly charts, the S&P is still—barely—bearish, primarily because of its failure to follow through on Thursday and Friday, after the Fed’s ‘no taper’ announcement.
With respect to the taper, more economic and market analysts are asking the obvious question—-if the Fed thinks it’s too risky to shave just a tiny portion of its monetary stimulus program, just how fragile are things, in the markets and more importantly, in the broader economy?
The answer, as discussed endlessly here, is that the US economy is on thin ice, and that the US financial markets are in even worse shape—they’re in bubble territory, just waiting to burst.
The Fed’s decision this week, it can be reasonably argued, proves this point.
And on a related note, one can wonder—-if, fully five years after starting them, the Fed’s QE programs (all of them) have failed to put the US economy on firm ground, how is it possible that ‘more of the same’ will actually do so? In other words, if the medicine hasn’t cured the disease, is the answer to just up the dose?
Clearly, the Fed’s monetary policy has failed to produce the desired results—put GDP growth on solid ground. And at the same time, this policy has created dangerous distortions and bubbles in many financial markets, with stocks being just one of them.
This will not end well.