“Tell me you’re not leaving
Say you changed your mind now
That I am only dreaming
That this is not goodbye
This is starting over
If you wanna know
I don’t wanna let go
So say it isn’t so”
“Say it isn’t so”…Gareth Gates
This week was almost a carbon copy of last week. For two weeks in a row the averages tested the 1,600 level on the S&P 500 Index and then bounced higher. That was also the level where technicians predicted the market would find support (at what is called the fifty day moving average).
Don’t worry; I’m not going to get all technical on you. It is sufficient to note that buyers stepped in at the same level that they did last week. And that is understandable since there really is no reason to go much lower than that. I have been looking for a mild pull back in the 5-7% range and that is exactly what we are getting.
If you have been reading my columns, you know that the Fed has provided the excuse the markets needed for this decline. As such, all eyes will be focused this coming week on the central bank’s FOMC meeting. Investors are hoping for some clue or hint among the meeting minutes to gauge whether the Fed’s intention to taper their stimulus program has firmed or weakened.
I believe the markets are misinterpreting the Fed’s actions. Nonetheless, the fear that the Fed plans to decrease the level of stimulus, if only modestly, is having a damaging effect on interest rates. In addition, investors are now wondering if the Fed’s commitment to keep interest rates low, at least until the unemployment rate declines to 6.5%, is in jeopardy as well.
All sorts of interest and dividend yielding securities from U.S. Treasury bonds to preferred stocks have seen a downdraft in prices as a result. In the housing market, mortgage refinancing has dried up as 30-year mortgage rates hit 4%.
This is not what the Fed expected, in my opinion. They have acknowledged that in the past their on-again, off- again quantitative easing programs caused an uneven recovery in the economy and volatility in the markets. For the Fed, the trick is to wean the markets off central bank stimulus without causing the same results. That is easier said than done.
To be fair, the Fed has already accomplished some truly stupendous results over the last few years. They have kept us out of another Depression and initiated an economic recovery, even if it is slower than we would have liked. Their stimulus efforts in the financial markets have succeeded in recouping all of our stock market losses and then some. The housing market, which triggered the financial crisis, is a much bigger problem. But even there we are seeing a rebound as a result of their efforts
What would help would be stronger economic growth. A few back-to-back quarters of plus 3% growth would re-focus investors away from Fed stimulus and back where it belongs on the free market economy. Unfortunately, this grand central bank experiment is like any experiment. There is a lot of guess work involved. If, for example, the Fed were to wait until after one or two strong quarters of growth to taper, there is a risk that inflation could spike. That would force the Fed to ratchet up interest rates and torpedo the economy altogether. If they act now, they risk slower growth or even a recession.
As for financial markets, it is understandable that the Fed wants to inject some uncertainty back into the markets. Uncertainty is a key ingredient in investing. If investors believe the Fed will always have their back in the form of more and more stimulus, then investing becomes a one way street. It can create a bubble in stock prices just as easily as it created a bubble in the housing markets over the last decade. So as much as we would all like to hear the Fed say it isn’t so, we need to be aware that at some point in the future they are going to take away the punch bowl.