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Why the Fed's 'Taper Tantrum' Doesn't Matter - views
BALTIMORE (Stockpickr) -- The hysteria surrounding the possibility that the Fed would turn off the spigot became palpable in yesterday's trading session. On Thursday, the S&P 500 index closed 2.5% lower than it opened, posting the single-worst trading session for the big index in 2013 -- and the worst since November 2011, in fact.
Perhaps more significant, yesterday's S&P 500 decline pushed the big index to close below its 50-day moving average, a line that's acted as crucial support over the course of this orderly rally. If there's a single word to describe how investors feel right now, it's "panicked."
But the Fed's taper tantrum doesn't matter. If you think that Chairman Bernanke's checkbook is slamming shut in 2013, you're wrong. And the implications remain the same for stocks: higher ground.
Most people have the cause and effects of quantitative easing flip-flopped. Ask 10 investors what Bernanke is trying to achieve by buying up Treasuries and agency MBS, and you'll probably get 10 different answers. I'll give you a hint: It's not jobs, it's not GDP growth, it's not stock prices, and it's not even the obliteration of gold prices. Instead, he's targeting one thing: deflation.
Or more specifically, he's targeting a pretty narrow definition of inflation, a 2.2% minimum in the Fed's 5-Year Forward Inflation Rate. (That's 0.2% higher than the Fed's stated 2% target for inflation.)
Take a look at how well that 2.2% level acted as signal to open the floodgates on another round of QE all the way through last year:
Every time the Fed's internal measure of forward inflation dipped below 2.2% between 2008 and 2011, the Fed announced a far-reaching new quantitative easing program. It was like clockwork. But then, something changed in 2012. Suddenly, Bernanke and company got more aggressive -- and more willing to launch new QE initiatives.
As the chart shows, QE3 and QE4 were very different animals than the first three rounds of quantitative easing (including Operation Twist). But that makes sense. After all, each of the first three rounds were a stop gap designed to keep the economy from the perils of deflation. With QE3 and QE4, the Fed was giving the economy a shot in the arm, hoping to jumpstart an uptrend in inflation before it got to that precarious point.
It didn't work.
The most recent quarter sunk inflation rates once again -- and at the same vertical pace that spurred the Fed to shovel more liquidity into the system in QE1, QE2 and Operation Twist. In my view, it doesn't matter what Bernanke says in his latest public statements about tapering easing off by 2014; if his go-to QE gauge falls below the "caution" level again, he's going to pick up the red phone on his desk and start shouting "BUY!"
Talk Is Cheap, QE Isn't
So why then did Bernanke talk the taper talk on Wednesday? In my view, it probably has a lot more to do with testing the water (a la QE3&4) than it does with actually pulling the e-brake on QE actions.
Look, Ben Bernanke is on a mission. Our boat is sinking, and he's been tasked with pulling out water by the bucketful so that he can plug the hole. The stakes are high, and he's going to use every tool at his disposal to do it. Fed statements are just another tool.
And frankly, talk is cheap, but QE isn't. It makes sense for the Fed to get aggressive with language before they get aggressive with even more spending.
We saw a similar investor reaction in September 2011, when the Fed announced Operation Twist and the S&P dropped 2.94%. The stock market wasn't a very good barometer for success considering how much inflation and other economic metrics improved afterwards. Bernanke and company are clearly hoping for a repeat performance.
A Structural Rally
There's no question that this rally has been structural. In other words, it's been caused by forced other than happy stock buying. Retail investors have remained skeptical of stocks for a long time now, and yet stock prices have kept climbing. But we're getting to the point now where more and more investors are making a transition to equities -- even if they don't want to.
In early 2013, the S&P 500's dividend yield climbed above the 10-year treasury yield for the second sustained time in four decades. When stocks are beating fixed income in terms of both capital gains and income generation, it's only a matter of time before investors' opportunity cost pain threshold gets exceeded. No matter how painful 2008 was, you can't miss the biggest rally in a generation and still feel like you're doing the right thing with your money. You just can't.
And just as important, cash has been a pretty poor alternative to equities. The U.S. dollar may be the best in breed currency right now, but it's the best of a really crappy breed.
Back in April, I said to fight your urge to fight the Fed. My take on how to treat this market hasn't changed much. Even though yesterday's big drop in the S&P points to a more painful correction in the near-term, the primary uptrend from 2009 is still very much intact.
Translation: This is still a buy-the-dips market in the long-term.
Two Sides of One Coin
In the last few months, I've heard some very convincing arguments for shorting stocks. Many of them have come from folks a lot smarter than I am. But when you zoom out to a more macro view of the global financial markets, those arguments fall flat.
In a nutshell, if you think stocks are going to drop, you have to think that something else is going to increase. In other words, the money coming out of the stock market has to go somewhere else.
The devaluation of the dollar (relative to other asset classes, not other currencies) has been a major source of fuel for our current structural rally. So, are shorts arguing that the dollar is suddenly going to skyrocket in value without Fed intervention? Sounds unlikely. For the reasons I've already mentioned, the Fed isn't really tapering QE indiscriminately.
Is there going to be a rotation from equities to commodities then? Not if recent price action in gold or oil are any indication.
Stocks are still the most attractive asset out there by virtue of the fact that investors have no other choice. That's not the most exciting driver of a rally, but it's reality. The Fed's taper isn't going to pull the plug on upside in stocks -- at least not in the intermediate and long-term. Once the gut reaction to Wednesday's statement wears off, the rally is going to carry back on.
Broad market ETFs such as the SPDR S&P 500 ETF (SPY) and the PowerShares QQQ Trust (QQQ) remain some of the most attractive ways to get exposure to the trend right now. But this is still a stock-picker's market. Names with increasing relative strength will continue to be the best way to buy stocks in the near-and-long-term, just like they were during this latest correction.
At the end of the day, no one seems to like stocks right now. But to paraphrase the great Walter Deemer, Putnam's head of market analysis in the 1970s, "when it comes time to buy, you won't want to." Sounds like it's time to be a buyer.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.
Follow Jonas on Twitter @JonasElmerraji
Follow Jonas on Twitter @JonasElmerraji