Sense on Cents

The consensus opinion by most market strategists coming into the year was that our equity markets would follow up the 25-30% gains of 2013 with another 8-10% gain this year.

The markets will have to experience a hellacious rally in the next two trading days or make an exception to an age old rule that January’s price action sets the direction for the year as a whole.

So what is going on with the markets? Are they simply experiencing a long overdue pullback? No doubt about that. Aside from a mild pullback last August and September of approximately 3-4%, the S&P 500 Index went straight up for the next 3 months to the tune of 12% to end the year with a 30% gain.

The 4% loss year to date certainly qualifies as a pullback but comes nowhere close to qualifying as a correction which market technicians define as a 10% decline.  The S&P 500 would have to retrace another 110 points on top of the ~75 points it has lost year to date to meet that definition. 

Although many holders of stocks might never like to see pullbacks or corrections, that is not the way markets work nor is it healthy. In order to build a stronger foundation so that the market can move to higher levels, it is not only good but, dare I say, necessary that the market retrace and ultimately retest prior levels that seemed to provide meaningful resistance prior to a market’s move higher. On this note, I think it is a good thing for our market as a whole if we do get a further decline.

But let’s take off the optimistic hat I was just wearing that is worn by most strategists on the street and ask, why is the market pulling back and will those factors continue to weigh heavily on the equity market?

We hear of dislocations and economic slowdowns in a variety of emerging markets from Argentina to Turkey to China. Did you know that these were coming? We hear of renewed anxieties and writedowns in the European banking system. Again, this news was not widely projected and hit the market as a surprise. We witnessed a mixed bag of earnings in the recent corporate releases on the heels of a weak employment report here at home. All of this news came to the market as disappointing developments, if not total surprises.

What is not a surprise and is certainly a huge factor in the market’s decline year to date? The Federal Reserve’s pulling back from its quantitative easing program. Ben Bernanke wants to go into the history books as having started the Fed’s winding down of the most aggressive central banking program likely — and hopefully ever — undertaken.

So while we do not know what the tarot cards might read for emerging markets, bank earnings, and our global economy going forward, what we do know right now is that the Federal Reserve intends on continuing to wind down its quantitative easing program over the balance of this year.

That program had been injecting $85 billion a month into the market and totaled an increase in the Fed’s balance sheet of ~$3 trillion. Having informed the markets that it would only direct $75 billion into the market in January and just this week announced that it would commit $65 billion in QE for February, those in the markets who have enjoyed the liquidity provided by the Fed should be aware that it intends to wind this program down completely over the balance of this year.

Rule #1 in the markets: ‘Follow the Fed,’ or in similar fashion, ‘Don’t fight the Fed.’

Heavy cynics might equate the overall price action in the market akin to a pump and dump scheme, but those engaged in such practices (like the wolf of Wall Street) do not tell you their plans.

The Federal Reserve is telling us exactly what it intends to do. This is not to say that the Fed might not change those plans especially if the market pullback creates serious dislocations and is perceived as negatively impacting the economy. But is that a bet you are willing to make?

Add it all up and what do we have? A market dynamic that remains in uncharted waters. So while Mr. Alfred E. Neuman may not be concerned, as always around these parts, we should navigate accordingly.

Larry Doyle

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The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

This entry was posted on Thursday, January 30th, 2014 at 7:02 AM and is filed under Federal Reserve, General, markets, quantitative easing. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.