Random Thoughts: What If the Market Snubs Fed Policy?
Unintended consequences pave a path to the most bearish outcome.
Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.
There's been a lot of talk lately about the bullish stars aligning into year-end; a perfect storm of open-ended data-dependent policy, doves on deck at the Federal Reserve, and underinvested fund managers with performance anxiety that would make Bob Dole blush.
In successive sessions, policy hawk Larry Summers removed his name from the chairmanship stakes; Janet Yellen, the most natural extension of current policy, was leaked as heir apparent; and, of course, the shot heard 'round the world: an about-face on tapering.
All of this occurred in the context of a technical breakout in the S&P (INDEXSP:.INX) as the cup-and-handle pattern triggered to the upside. One could posit this series of events was a moment of financial serendipity. Or perhaps it is an extension of The War on Capitalism, which has turned politicians and policymakers into traders much like the dot-com bubble once did for taxi drivers and stay-at-home moms.
Lost in the euphoria is the simple truth that, in their effort to manipulate prices higher, policymakers opened the door to the single most bearish scenario: a rise in rates in the face of "no taper," a tangible manifestation of the deterioration of faith in the Federal Reserve.
Credit of a different breed -- that of credibility -- has always been the issue at hand for the markets at large.
Having this discussion with markets at all-time highs is like screaming into the Grand Canyon; few want to hear it, and those that do will file it away for a later date (when rates rise). Be that as it may, it's interesting to note this "unintended consequence" would not be on the table if the Fed did what it hinted at for the better part of the year; it was a bit of a bait-and-switch to a global audience with thinned patience.
I watched Stan Druckenmiller's recent CNBC interview last night for the first time. There are few financial seers whose views I hold in higher regard than Druck, who foresees "a party" before the eventual comeuppance, which he expects to be brutal. He knows markets can reset quickly on little or no volume and the ensuing negative wealth effect isn't on a lot of radars. Yes, timing is everything.
As a trader, a stair-step process that manages risk rather than chases reward is the order of the day. As an investor, the onus is on each of us to see all sides, particularly when one side seems overwhelmingly obvious. We've lived through almost 15 years of savers being punished at the bottom and investors being screwed at the top.
That might be a thing of the past, but that requires a leap of faith and a matter of trust.
There's an old adage that you can drive from New York to California with your headlights illuminating only 20 feet in front of you the entire time; that's the mindset for active trading, where a stair-step process trumps big-picture concerns seven ways 'til Sunday.
That approach is being debated across the Street as macro funds attempt to shift their style to capture reward. With the Dow (INDEXDJX:.DJI) and S&P up 20% -- and Nasdaq (INDEXNASDAQ:.IXIC) up 25% -- those who have relied on traditional metrics (such as the market being an extension of the underlying economy in any way, shape, or form) have found themselves playing ketchup in the evolving long squeeze.
S&P 1710 (former resistance) is next-step support -- with S&P 1655 below that -- as the market casts a forward eye on the potential government shutdown. Of course, each and every potential negative has been swallowed by the bulls so you can excuse them for not feigning concern.
- It is worth noting that the S&P teased the bulls with similar breakouts in May and August before providing requisite pullbacks of 8% and 5%, respectively.
- Of course, even the bears are conditioned to cover up quick given the pungent smell of singed fur, which begs the question of where we are on the second chart below.
Much like we will never know what would have happened if we didn't invade Iraq on the premise of WMD, we'll never know "the other side" of tapering. My concern is that we will continue to pursue the same policies that created the crisis in the first place with hopes that we'll somehow avoid the same punishment.
In Flow's Diner, we're seeing a rotation out of regional and super-regional banks (Zions Bancorporation (NASDAQ:ZION), Fifth Third Bancorp (NASDAQ:FITB), etc) and into asset managers (and money centers to a lesser degree). The regional banks were a place to park as the taper tantrum permeated the mainstream mindset, as the perception is that they have less interest rate risk.
I always envisioned the "weeding out process" to occur during a prolonged period of market malaise, but I'm beginning to wonder if THIS is the weeding out process, at least for the bears.
On Friday, we offered that an analog of gold vs. S&P since the blast-off in 2009 supported the notion that gold should rally or the S&P should come for sale, or some combination thereof would occur.
- Given the rally in gold, that must have begun, right? Well, not so much; an updated snapshot below demonstrates that the chasm remains wide, at least relative to the correlation during the last few years.
Have a great weekend; you've most certainly earned it.
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Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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