Opinion

James Saft

Fed taper may be vindicated, but watch from a distance: James Saft

January 14, 2014

Jan 14 (Reuters) – Sure, the Federal Reserve will probably
carry on tapering, and sure, they may ultimately be vindicated
by better economic data, but it is hard to see why you, as an
equity investor, should stick around to find out.

Friday’s U.S. jobs data, the worst by some measures in
years, was the equivalent for the Fed of one of those scenes in
a movie where the ground at the cliff face begins to give way
beneath the hero’s feet.

Having just last month inaugurated what they and investors
hope would be a stately and calm process of reeling back on the
amount of bond buying the Fed does every month, beginning with a
cut from $85 billion to $75 billion, the U.S. central bank was
unexpectedly confronted with some inconvenient facts. Not only
were the payroll figures the worst in nearly three years,
confounding market expectations, but the unemployment rate,
which is at the center of the Fed’s policy of trying to manage
longer-term expectations for when it will actually raise rates,
fell to 6.7 percent.

That, just a hair above the 6.5 percent rate at which the
Fed says is an important threshold in its thinking about when to
raise rates, threatens to make a confusing mockery of the policy
of “forward guidance”, under which it tries to anchor rate
expectations by tying its policy to future economic data.

This is all gripping stuff, and likely will transfix
financial markets for months if not years to come, but the
typical investor might be forgiven if she decides, by taking a
bit of those fat gains from 2013 off the table, to make it more
of a spectator sport and less a trial by ordeal.

There are plenty of good reasons for caution. In descending
order, the first four: The Fed, which has launched itself down a
chute which will be difficult to climb back up; the economy,
which may not be playing along with the Fed’s desire to
normalize policy; the stock market, which is expensive; and
company earnings, which may be rolling over.

The Fed bathed in a warm sea of praise when it began the
taper, with the general consensus being that, preceding Ben
Bernanke’s exit as chairman by a month, the move marked a
fitting end to a job well done and a crisis well handled.

THE COST OF A CLIMB-DOWN

That may or may not be true, but what is incontrovertible is
that the Fed now has a large investment in the taper in terms of
its prestige and credibility. It will be psychologically
difficult to climb down. Reverse course now and investors will
quite rightly wonder what to expect next.

Everyone, especially central bankers, say they follow John
Maynard Keynes’ supposed practice of changing his mind when the
facts change, but everyone also hopes to heaven they never have
to.

So we can probably count on the Fed to wait for more data to
confirm their thesis of a slow but steady jobs recovery, while
in the meantime financial markets will be forced to contend with
the withdrawal of a real stimulus.

They also often wait too long. At the point at which the
Fed’s psychological sunk costs in the tapering exercise are
exceeded, they could find themselves expensively behind the
curve of events.

Meanwhile the jobs data paints a picture of an economy which
not only can’t produce jobs, but continues to have trouble
producing gains in income for those lucky enough to be working.
Hours worked are stagnant, as are earnings compared to
inflation. And if you are looking for a hot field, look no
further than temporary employment, but don’t expect benefits or
job security.

And with the S&P 500 index trading at nearly 16 times
investors’ rather optimistic expectations for next year’s
earnings, we can’t say it is cheap. Nor do companies, especially
in technology, look inexpensive when compared to sales. Company
shares have risen in value at least in part because Fed policy
encouraged money to flow into the stock market. Now that that
flow is reversing, other factors will need to pick up the slack
or prices will fall.

And now, with the Fed locked into tapering, at least in
January, stocks may face a serious test in coming days as
companies release their fourth-quarter earnings results. At
first glance, investors are optimistic, penciling in an
expectation that earning rise 7.3 percent. Look beneath the
surface though and optimism is fast eroding. According to
Thomson Reuters data nearly 10 times more companies are guiding
earnings expectations lower than higher, the most on record.

Let the Federal Reserve stick to its guns, but you may want
to be out of the line of fire.

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