Syria is getting all the blame for the market's current
nervousness, with Tuesday's House leadership's support for
strikes cited as the reason for deflating the day's earlier
market gains. The prospect of another conflict in the Middle East
is no doubt destabilizing, but I doubt if Syria is the primary
source of current market nervousness.
There is always more than force at play and Syria is likely
playing some role on the margin, but the primary unsettling
factor for the market is the Fed. Tuesday's pullback was not so
much a reaction to the show of support from House GOP leaders,
but rather a reaction to greater likelihood of Taper announcement
in this month's FOMC meeting following the strong ISM numbers. We
don't have much economic data on today's docket, other than the
trade deficit in the morning and the Beige Book later this
afternoon, but Thursday and Friday bring important labor
that is very important for Fed watchers.
One would think that stock market investors would have gone past
the Taper issue by now. But many appear still to be hoping for
the Fed to hold off on announcing any changes on September 18th.
They are pinning their hopes on the Fed continuing with the QE
program in full force till the budget/debt ceiling fight in
Washington is amicably settled. I don't think it matters much
whether the Taper announcement comes this month or a couple of
months down the road, as it is practically a given at this stage
that the Fed is preparing to get out of the QE business. My sense
is that Bernanke wants to move past the Taper issue on his watch,
leaving his successor all the flexibility he (or she) will need
to proceed from January onwards.
The issue isn't so much the amount of 'Taper' either, it's about
what the move tells us about the central bank's the long-term
monetary stance. Bernanke and others on the FOMC have been going
to great lengths to emphasize that the overall stance of monetary
policy will remain extraordinarily accommodative even after Taper
gets underway. All the Fed efforts at forward guidance and
unemployment rate targets are geared towards emphasizing this
aspect. But the bond market sees the Taper not just as a mere
reduction in monthly bond purchases, but as the start of a long
run monetary policy normalization process.
Taper and the expected changes to Fed policy are not cataclysmic
events, but they do represent a material shift in the super
accommodative macro framework of the last few years that was very
beneficial to the stock market. Everything else equal, the stock
market will find a new equilibrium level in response to this Fed
change. In the absence of a material improvement in corporate
fundamentals, the market's new equilibrium level is likely a lot
lower than current levels. Brace yourself for a bumpy ride in the
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