Early holiday courtesy of Fed
Oct 30 (Reuters) – Gorge on Halloween candy, Thanksgiving
turkey and risk: the Fed has declared an early and extended
The Federal Reserve left policy unchanged at its meeting on
Wednesday, maintaining its $85 billion per month schedule of
bond buying and making only a few changes to the accompanying
The Fed said it wanted to see more data before making any
changes to policy, while noting that the recovery in housing has
slowed and inflation remains below target.
With no meeting until December and little sign of an
economic resurgence in the wake of the government shutdown, it
is looking like investors will not face a “taper” of the Fed’s
bond buying program until 2014, possibly at the March meeting at
which Janet Yellen will make her debut as chair.
The upshot, for good or ill, is that equities and other
risky assets have a clear and greased path between now and the
end of the year. That of course is exactly how people have been
Despite rather tepid U.S. corporate earnings this season and
some evidence that consumers pulled in their horns during and
after the shutdown, major stock market indices are at nominal
all-time highs. You might call this a cynical rally, but it is a
real one with real money changing hands. And remember, the old
adage “don’t fight the Fed” is arguably more true now than it
has ever been.
Stephen Jen at hedge fund SLJ Macro Partners has done
research showing that the Federal Reserve is three times more
powerful in driving equity markets over the past decade compared
with 1980-2002. SLJ research shows that Fed actions now account
for 40 percent of equity market variations compared with just 15
percent from corporate earnings.
“In sum, if the U.S. economy remains lukewarm in the
remainder of the year, it is likely that we see the following:
higher equity prices, lower bond yields and a relatively stable
dollar, i.e., a dollar that will struggle to go lower, despite a
dovish Fed,” Jen and colleague Fatih Yilmaz wrote in a note to
To be sure, there is always the possibility that the Fed
surprises with a December or January taper, or that there is
some testimony from Yellen at her congressional approval
hearings that ups taper expectations, but the stars would have
to go some way to come into alignment for that to happen.
Indeed, in some way the scariest thing is the extent to which
this is all baked into everyone’s expectations.
NO BEARS LEFT TO HUNT
Even if a stock market rally into year-end is the most
likely outcome, the sheer power of everyone having the same
expectations and trying to fit through the same door raises the
costs if expectations are not met.
In the past few days there have been multiple data points
indicating how aligned most investors are.
Options markets demonstrate that most investors are
positioned for gains, with some measures of investor optimism at
near year highs.
Pessimism in the AAII Sentiment Survey of individual
investors fell to a 21-month low and optimism rose to a 10-month
high. The proportion of investment newsletters that are bearish
measured by Investors Intelligence is as low as it has been
since 2011 and is in territory touched only four times in the
So, what are the risks?
Probably there are only marginal ones between now and the
end of the year. U.S. politics will simmer but will not become a
focus until into 2014.
Europe and Japan are, if anything, more likely to be sources
of positive news than negative shocks. There are no other
geo-political issues on the immediate horizon that would unduly
And of course, there is the fact that an up year in markets
may force the hands of whomever has been underweight risk.
Self-preservation is a powerful incentive and presenting a
bearish portfolio in year-end investor letters is not going to
be popular this year.
In some ways the biggest risk may simply be a period of
quiet in which investors can begin to puzzle out why exactly
they are so optimistic about the stream of future earnings their
stocks represent. While this earnings period has been fine,
again we have seen better performance on earnings than on
revenues. Bottom line growth cannot outpace topline growth
And too, the Fed may well want to send a message, after the
confirmation hearings of Yellen, that the taper cannot be put
off forever. When the taper comes, the biggest factor in equity
markets will be pushing down not up. That implies considerable
When that happens, the holiday bills will come due.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
(Editing by Clive McKeef and Dan Grebler)