It's Tuesday October 22 and the
delayed September employment announcement
shows disappointing progress on hiring - bad news for the economy
and for stocks, right? Well, if the valuation of the stock market
had anything to do with the real economy, you would be right,
have been bad news for stock prices as well. But stocks ended the
day up over half a percent. It turns out that markets now think
that bad news for the economy is good news for the stock market.
paranormal market activity
What's going on here?
Bad news is good news for stocks as it implies a longer period
of Fed accommodation, which has been propping up risk asset
prices. This behavior illustrates the overwhelming market
consensus: the economy is too weak and too dependent on
"financial market conditions" to consider a pullback in
quantitative easing -the Fed's bond-buying program, let alone an
abandonment of zero interest rates. Here's how the Fed
policies benefit stocks and other risk assets:
- They create more money in the financial system that has the
effect of pushing up financial asset prices.
- It reinforces the idea that the Fed will continue to hold
interest rates at zero, which compels investors to seek out
higher (than zero) returns.
- The increase in the demand for risky assets (as opposed to
government bond assets or cash) pushes up the value of risky
assets, of which stocks and fixed income credit such as high
yield and bank loans, are prime beneficiaries.
Here's what this paranormal activity looks like in the
market-when better-than-expected economic news hits, stocks drop
and vice versa:
How long will paranormal activity continue?
Likely until investors finally get clarity around when the Fed
will act. If the Fed can convince markets
that short-term interest rates won't spike again
like in May-July of this year, then the next taper conversation
may be less bumpy for markets. That, however is a big 'if,' and
the Fed may not be able to orchestrate such an outcome. While we
expect tapering of the Fed's bond-buying program to be deferred
into next year, the possibility of the Fed moving sooner than
markets expect represents a key risk to the short-term
What does this mean for investors?
Given the market consensus that the economy isn't healthy
enough to advance without accommodative Fed policies, we now see
greater downside than upside to the risky segments of fixed
income (high yield bonds, bank loans and securitized assets).
While longer term we continue to view these asset classes
favorably, our downgrade to "neutral" from "overweight" reflects
their diminished risk/reward tradeoff over the next one- to
Jeffrey Rosenberg, Managing Director, is BlackRock's
Chief Investment Strategist for Fixed Income, and a
regular contributor to
You can find more of his posts