Over the last couple of decades, information flow for the retail investor and trader has grown enormously. Instant access to government issued data such as the jobs report and CPI and GDP numbers is now the norm. As that has happened, so the focus of the market has become increasingly narrow. I remember the anticipation that was felt in the currency markets as major US releases approached. In my days in Tokyo the whole office would return late at night in order to be there for the major releases.
I doubt that happens anymore. The increased access, combined with the development of algorithmic trading to take advantage of, and even generate, the immediate reaction to such events has resulted in actual people stepping back and looking at the numbers differently. The tendency now is to go out to the extremes; either looking for evidence of long term trends in the monthly releases or looking at short term data in an attempt to predict what the number will be.
Over the next couple of months, however, both approaches will have little use, according to the conventional wisdom. The Government shutdown and uncertainty caused by the debt limit issue is gone, at least for now, but the effects will be evident in major economic data released this month. This, so the argument goes, will result in the significance of even major economic figures being reduced.
Unemployment and Gross Domestic Product (GDP) are lagging indicators, meaning that they report what has happened, well after the event. Both of these things, in the month of October, will have been affected by the shutdown and the uncertainty that surrounded it, but to what extent is unclear. There is a feeling that, because of this, the market will shrug off any bad news and focus only on any hint of positivity. November, therefore, will be a great month for stocks.
Whenever I hear multiple analysts and commentators making the same argument, though, I get a little nervous.
The problem is that, in matters of markets, everything is measured against expectations. It seems that expectations for the economic health of the US are low, but those for the stock market are high. What makes this possible, of course, is the Fed. As long as they keep pumping $85 Billion per month into the market it is hard to see anything but rising asset prices, and any signs of economic weakness are simply going to ensure that QE continues at current levels, so there is no need to worry.
In my opinion, however, this is exactly why we should worry.
I am not a “Fed is evil, QE was a disastrous mistake” kind of guy. I actually believe that, faced with a dual mandate and a sluggish economy, the Federal Reserve had little choice but to use what power they had to stimulate the financial system. The policy has been a success in terms of the stock market, but Bernanke et al are acutely aware that there are risks to it, and it must come to an end at some time.
The board, through the Chairman, began to remind us of this back in May and the S&P 500 lost 7.5% over the next month as a result.
Then, in August, when the consensus was that the tapering of bond purchases would begin, stocks took a pounding again in anticipation of that. As we now know, weakness in the economy and the upcoming Congressional showdown caused that action to be delayed. It was, however, delayed not cancelled. Bernanke has always maintained that, if economic conditions permit, tapering would begin this year.
With that in mind, let’s return to the expectations thing. It seems that everybody is expecting bad numbers for October’s lagging indicators, so that can likely be discounted, but what if the short term numbers for early November and more forward looking indicators, such as consumer sentiment, are decent in the coming weeks? If this is the case, then attention will return to the possibility of tapering beginning before the year is out.
Bernanke may be smart and powerful, but he is human and, I believe, is fundamentally honest. Thus, if November’s short term numbers indicate that the economy is showing resilience and recovering quickly from the wounds inflicted by the politicians, it is not a stretch to imagine him beginning to reduce bond purchases sooner than most now think.
Losses were painful when there was a hint of tapering. Imagine the situation if traders, buoyed by renewed optimism are caught by surprise and the thing actually happens!
Once again, I have to say that in the long term (years rather than weeks or months) I am still bullish for stocks. This is borne out by the long term trend analysis that I spoke of. It is just that, over the next few weeks, I believe caution is wise. There is too much chance that any good short term news will either be seen as indicating, or actually lead to, a quicker than generally anticipated reduction in QE.
If the market has been ignoring long term numbers and buying whatever, then reaction to anything of the sort will be nasty. Keep your eye on the short term numbers, and if they show hope, then I would reduce exposure to stocks before the next Fed announcement, just in case. If there is a surprise, then keep in mind that the reaction will be exaggerated and QE will continue, just at a lower rate, so the move will be temporary.
It seems we are in a counter-intuitive world. Not only is bad news now good and good news potentially very bad, but also, I, who usually stresses the long term, am suggesting that you watch the short term numbers. Topsy-turvy indeed!