Good News is Bad News?

In all the time I’ve been in this business, it’s always been a source of interest to me how nominally good news can create a negative effect on the markets.

Here’s an example of what I mean.

Many traders and investors are of the opinion that the Fed’s quantitative easing program is the main – if not only – reason the markets have done so well over these past few years. Therefore, to this group –and their many media enablers – the thought, suggestion, inference that the Fed may actually move to cut back the easing program is a source of high anxiety. With this anxiety comes the idea that, without this support, stocks are doomed – doomed, I tell you. So, to take that thinking one step further, if they’re doomed, then stocks must be sold before we slide back to 2008 2.0.

This crowd constantly watches the economic reports, decides what they think the effect each may have on the Fed’s thinking and then, trade accordingly. We saw some of that just this past week.

A little info on QE

QE, quantitative easing, is about the Fed buying Treasury securities. When whomever sells their T-securities to the Fed, the dollars for the trade are moved from the bank’s securities account (like a savings account at the Fed) to the bank’s reserve account, which is also at the Fed and is like a checking account. The number of dollars hasn’t changed at all – just in a different account. The point is that no money is being pushed into the economy as a result of this easing.

The conventional wisdom is that, by maintaining this easing, the Fed is forcing people up the risk spectrum in order to get the returns they want. So, by definition, they have to move into stocks. If the easing is reduced or eliminated, the thinking is that there would be a big swing out of stocks and back into “safer” investments.

GDP / NFP / ISM / DOL

To echo Brian Wesbury, if the economic reports we’ve seen over these past couple weeks are any indication of how we do when the Federal government is partially closed, I’m thinking we ought to make it more permanent. That’s because we had a string of important reports from that period that all came in much better than expected. Check these out.

The Gross Domestic Product for the third quarter (the first version of it, anyway) was expected to come in at 2% – it clocked in at 2.8%. (1) The non-farm payroll report (NFP) showed that job creation accelerated in October and that the data for the two prior months were revised higher as well. (2) We also learned that US manufacturing grew in October at its fastest pace in 2 ½ years and that the service sector of the economy, also during October, picked up more than expected. (3) And, filings for initial unemployment benefits continue to drop. (4)

To me, these all look pretty good. No shoot-the-lights out stuff but definitely showing ongoing economic improvement across the board at what you might think of as the foundation level. Nonetheless, last Wednesday, after the positive GDP info was released, good news became bad news. Here’s how that works…

Headlines

So, this past week, when the GDP data came out, the traders started selling. Makes no sense, on the face of it. If we have an improving, growing economy, it would seem to make sense that we’d be moving toward better company earnings. And, in most cases, with those improving earnings comes higher stock prices.

Then, on Friday, the NFP data came out. The averages moved lower initially but the bargain hunters and short-coverers stepped up and moved the markets higher by the close.

Given the way the markets have moved this year, money managers want and need to put up good numbers. The traders also want their books looking good at year-end. These, together with the fact that earnings season has just about been completed, mean you can be pretty sure that the markets will be reacting to daily developments…not fundamentals so much.

What if…

So, my thoughts notwithstanding, what will the market do when tapering begins?

My best guess is that what we saw on Wednesday will be magnified. We’ll get a bunch of selling, prices will drop and the resident doomsayers will be trotted out to tell us to repent (or sell), that the end is near. The key will be to not let your emotions cause you to break from your strategy.

The more important consideration to keep in mind is that when the Fed does begin tapering, it’s because they see improvement in the overall economy – the kind that doesn’t need a monetary 24/7 IV drip.

Seems to me that the only reason we still have QE today is because of ongoing global risk aversion. The demand for short-term safe stuff continues to be strong. Why else would there be, right now, over $7 Trillion in bank savings deposits; almost $1 Trillion in money market accounts; $1.4 Trillion in checking accounts and, oh yes, $2.5 Trillion in bank reserves all earning basically nothing. Households and businesses have never before held such a large portion of their annual incomes in cash. (5)

But…

This aversion can’t continue for much longer. Our economy, along with Europe’s and Asia’s, is improving. I think that some of the big drop in the gold price this year is directly due to this lessening of perceived risk.

Personally, I’m hoping the Fed will get their tapering show on the road sooner than later. We’ll be able to remove that from hanging over us and get back to letting the markets and the economy operate on their own.

Cheers!

Mike

509-747-3323

(1) Department of Commerce, 6 Nov 2013

(2) Census Bureau, 8 Nov 2013

(3) ISM, 5 Nov 2013

(4) Department of Labor, 7 Nov 2013

(5) Fisher Investments, 7 Nov 2013

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