To Taper or Not to Taper–That is The Question
Been an interesting couple weeks in the markets, don’t you think?
Economic and political announcements of some significance over this time have managed to surprise most of us. These reports have largely been positive – “better than expected” being the primary accompanying phrase. In no particular order, they’ve included the budget deal in Congress, a very strong third quarter GDP, the nonfarm payroll numbers putting up great results and the ISM manufacturing data blowing doors off. There are more of similar content. It’s very interesting to have seen so many so positive all at once.
Also interesting has been that for most of this year, whenever we’ve had good economic reports, the markets have tended to actually move down a bit. That changed a week ago Friday when the stock market moved up nicely in response to the nonfarm payrolls data…one day after having sold off because of the strong GDP data.
With all this news and the intra-day volatility that’s been around, I thought I’d check back to a month ago and see how the major stock market indices have responded to the news. We did set a couple new all-time highs in the Dow Industrials and S&P500 and traded to the highest point in 13 years in the NASDAQ. I found that, even after all these news announcements and the budget deal, the difference between the values in the stock indices was very small. (1)
Let me try and give you some insight into what I think is going on in the markets.
The Fed
The policy making arm of the Federal Reserve Bank (the Open Market Committee) meets this week. With a couple false starts as to whether the central bank would or would not begin tapering their bond purchases earlier this year, a lot of focus will be on the wording of the announcement that they issue.
One of the main reasons the market has been so quiet over the past couple months is due to the unknown effect of reducing the taper. Many – wrongfully, in my opinion – feel that the start of tapering means the end of the upward market. Many also believe that the tapering means short-term interest rates will also rise soon. In the latter case, the Fed has said that there is no linkage between tapering and the rates. Matter of fact, seems that rates have already anticipated the start of tapering. Here’s a great example.
At the end of April, right before Mr. Bernanke first suggested that there would be tapering at some point, the 10 year US Treasury note was priced at 1.70%. On the 13th of December, that same note was now at 2.88%. (2) That is a majormove in a very short time. So, this says the market feels that rates will rise further which some worry will also derail the stock market.
The calendar
Here’s a biggie.
Given how the stock market has done this year, portfolio managers and traders are very interested in what the Fed has to say. The consensus seems to be that if the tapering does begin, there will be at least a short-term drop in the markets. Given that it’s so close to year-end, seems to me that a lot of these folks will be selling so as to preserve both their year-to-date results as much as possible. So, if you’re one of those kinds of folks, you might want to have a defensive plan for what to do. If you’re a long-term investor, you may have the chance to take or add to positions as the underlying market, I believe, still looks very good.
A couple facts to support my view include that the long-term outlook for the S&P 500 is clearly bullish. Specifically, 83.0% of the 500 stocks in the index have bullish long-term trends. (3) A further demonstration of its width is shown by 7 new 52-week highs in individual stocks for every 52-week low in the S&P 1500 Composite (4).
Fed timing
The Fed has stated that they want to see the economy looking stronger before tapering. While the reports I mentioned above sure look strong, the FOMC may want a couple more solid reports first. As with the calendar, they may not want to act if they feel that doing so would undermine the markets or economy. Finally, there’s also the matter of the change of command coming at the Fed after year-end. Will Mr. Bernanke want to leave the initiation of the new policy to is successor or take it upon himself?
Conclusion
According to ISI Research, there have been 11 years since 1950 that the S&P 500 has posted 25% plus gains, which is roughly what we appear to be in store for this year.
After each of those 11 years, with the exception of two recession years in 1981 and 1990, the S&P posted positive results in the following year, with an average gain of over 16%. Additionally, Ned Davis Research provides excellent work on Presidential cycles. Since 1929, their work shows a many corrections in the second quarter of the second year of a Presidential cycle – which is 2014. The good news may be that those corrections historically have proven to be great buying opportunities, as, also according to Ned and his folks, the third and fourth quarters of the second year in an election cycle, and the first quarter of the third year, have posted the highest average gains of all.
My personal desire is that the training wheels come off, that the tapering does begin so that stocks, bonds and the overall market can move to operating on their own with future market returns being more reliant again on the lifeblood of stock-price appreciation…earnings growth.
In any regard, those companies in the cyclical sectors, such as consumer discretionary, energy, financials, industrials, materials and tech, seem to be best poised to benefit from our continuing recovery – taper or not.
Cheers!
(1) CNBC, 13 Dec 2013
(2) Treasury.gov, 13 Dec 2013
(3) Seeking Alpha 15 Dec 2013
(4) Bloomberg, 15 Dec 2013
Securities and Investment Advisory Services offered through KMS Financial Services, Inc.
To get an overview of economic conditions, use this link. It’s updated monthly.http://www.russell.com/Helping-Advisors/Markets/EconomicIndicatorsDashboard.aspx
Past performance is not indicative of future returns. Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.
Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
