Thursday, December 19, 2013

The Fed Decision 12/18/13 Aftermath; Bernanke Announces Taper; QE Infinity Ends; ZIRP Forever Begins; Stocks Rally

The QE taper arrives with a $10 billion per month reduction (split between $5 billion in bonds and $5 billion in mortgage securities) starting January but a bait-and-switch occurs with the Fed turning perhaps more dovish by extending low rates, well, forever. The QE Infinity program is replaced with the Low Rates Forever program. Interestingly, the QE programs and other stimulus measures were implemented by the Fed since the ZIRP, zero interest-rate policy, was not providing enough economic juice. Now the Fed is tossing the additional measures aside with the taper and instead main-lining a low rates forever policy--like tossing aside the wine coolers and supplying bottles of grain alcohol moonshine instead.

Chairman Bernanke says rates will remain low well beyond when the unemployment rate drops below 6.5%. He is likely hedging his bets since the unemployment benefits were not extended and the unemployment rate may drop towards 6.5% far faster than anyone realizes (many of the unemployed will simply not be counted in the rate any more once their benefits end). Then, if the economy does pick up, the unemployment rate will jump strongly higher (counterintuitively) as folks flood into the stronger job market trying to find jobs. Bernanke is trying to anticipate and front run this potential problem that is why he is hedging the 6.5% number. Overall, the Fed news is like taking away the stale hard candy from the coffee table but replacing it minutes later with fresh chocolate bars. 

Yields remain flat since the Fed decision yesterday afternoon. Instead of the stock market dropping on the news of the taper, a robust upside rally results, fueled by short-covering. Those seeking downside market protection in areas such as long volatility ran for the hills with the VIX collapsing from over 16 to under 14 in less than 2 hours.

But what has actually changed? The markets are continuing to respond in the same way. When news of the taper occurs in the first few minutes at 2 PM, the stock market plunged lower exhibiting the selling behavior that many traders expected, however, the bait-and-switch occurs immediately where Bernanke launches into a dovish presentation promising to be accommodative indefinitely, continuing to grow the balance sheet, and to keep rates low for the foreseeable future easily into and perhaps through 2016. This is unprecedented since the ZIRP would be in affect for 8 years, or more, as 2016 rolls around. Of greater interest is that no one appears bothered by this development. In addition, Bernanke restates yesterday, and Yellen agrees, that there are no asset bubbles in markets currently (the Fed has never been capable of identifying a bubble ahead of time in its entire 100-year history). The stock market catapults higher on the news. So the markets simply respond to the new candy. Low rates forever means companies can continue to fund buybacks to artificially pump the EPS higher and meet earnings goals. If earnings increase, stock prices increase. Traders do not care that the EPS is met through creative accounting rather than actual top line revenue growth.

The QE tapering is starting in January 2014, next month, at $10 billion per month.  The current program is $85 billion per month of purchases. Thus, moving into February the purchases will be $75 billion per month and then drop $10 billion each month forward. Bernanke left the door open to adjusting the speed of the tapering, he says the process is data-dependent, but for obvious reasons, since it would indicate that his grand 5-year economic experiment is failing, the Fed will not want to go back and increase QE again. Taking the $10 billion number, simple division says 7-1/2 months are needed from February to the end of QE Infinity. This is the August-September 2014 time frame. If the economy turns south moving forward, the Fed will likely slow the QE tapering, so QE Infinity could continue through next year. These are reasons for the market bulls to be happy as the near 300-point upside move on the Dow shows. Bernanke wanted to button-up his tenure at the Fed with starting the QE taper, and he did. However, did Bernanke really begin the taper due to upbeat economic data, or, did he taper to mask his concern and fear over the growing size of the Fed balance sheet? Bernanke may have brilliantly masked this fear within the QE taper and extended low rates announcement yesterday. Magicians have a much easier time at fooling the audience when the audience wants to be fooled.

The path ahead splits into many side routes now. What happens to the stock market if the economic data stalls and the QE tapering slows? Since the universal market consensus appears to now believe the stock market is rallying because the economy is improving and becoming better each day, if the economy weakens, would stocks sell off? The answer is probably not. As mentioned above, the same routine is in play. Stocks plummeted on news of the taper, but when the next sentences turned uber dovish and now a Low Rate Forever policy begins, stocks catapulted higher. What happens if the economy does accelerate into 2014 (despite the lackluster retail sales, lack of top line company revenue growth and continuing disinflation and deflation), does the stock market rally further? Or will stocks drop since the punch bowl will be removed quicker? Obviously, the Fed is the markets, and has been for the last 5 years. The saga continues.

The stock rally after the Fed's new Low Rates Forever policy results in indiscriminate buying. The shorts were running for their lives and all sectors move higher. There is only one last bear remaining in the market and he is at the bus station waiting for the last ride out of town. Interestingly, the interest-rate sensitive stocks such as telecom, home builders and utilities bounced strongly, but, so did the banks. One of them is wrong. The 10-year yield holds steady at 2.88%. Markets cannot have it both ways. Either yields will leak lower moving forward (note and bond prices move higher) which says the interest-rate sensitive stocks are correct, or, yields will move higher which will crush the interest-rate sensitive stocks and reward the banks due to the steepening yield curve.

The dollar popped on the Fed news with the dollar/yen leaping to 104.36, a phenomenal currency move. The weaker yen creates that Banzai! feeling and fuels the U.S. and Japan stock markets higher. The dollar/yen maintains buoyancy above 104 currently which will help maintain buoyancy in equities. Despite the joyous rally, the charts and technicals continue to signal a significant market top now in place or developing with an anticipated roll over to the downside expected at any time. The Fed announcement will help fuel the Santa Claus rally and favors the bulls through the end of the year. Long traders wave the ZIRP Forever banner. Obviously, all the long side buyers fully expect a continued rally using yesterday's enthusiasm as a guide. However, since the presents were delivered to the stock market early, one week before Christmas after all, Santa Claus may still fail to show at Broad and Wall.

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