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Will the Federal Reserve Disprove Sir Isaac Newton?

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The central bank challenges the laws of motion.

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Editor's Note: Todd posts his vibes in real time each day on our Buzz & Banter.

Well the joint was jumpin', going 'round and 'round. Hey! realin' and a rockin,' what a crazy sound.
Well they never stopped rockin' till the moon went down.
..
--Grateful Dead

Yesterday we asked if the FOMC would bless the equity melt-up; in the early afternoon, we got our answer.

In this bizarro environment, where good news is bad (implies tapering) and bad news is good (pushes tapering), the on-the-margin hawkish commentary from the Federal Reserve was viewed as an incremental negative, as some perceived the "sequence" of tapering could begin a few months prior than previous expectations.

Forget for a moment that economists recently suggested that the Fed would avoid massive losses by never selling mortgage-backed securities from its record $2.84 trillion balance sheet; "Project Rug Sweep" has been the cause célèbre of a rally that drove 92.2% of the S&P (INDEXSP:.INX) higher this year with an average gain of 29.96%. Sir Isaac Newton got this one wrong; every action does not have an equal and opposite reaction, or so it would seem.

Given the ability of the Fed to control the money supply (or digital credit, as the case may be), the question that's begged is whether there will be a comeuppance -- and if there is, how it will manifest. There are several emerging hot-button issues -- the prevailing direction of social mood and increasingly strained foreign relations, among them -- but they've been a distant chorus to the price action on the main stage. And as we know all too well, the stock market was designed to be the world's largest thermometer.

I've asked some of the smarter market observers I know to poke holes in this strategy, posing the question, "If FASB 157 (mark-to-market) never comes back in our lifetime and the Fed holds to maturity, is it 'really' possible that it can sweep all this under the rug?" I wrote a column several months ago likening the Fed policy to the put-writing strategies of high-tech companies in the late '90s; it worked great until it didn't, and when it didn't, it simply wrote off its losses and never looked back.

The hard-core skeptics maintain "this" will matter, although there wasn't a uniform view in the timing or catalyst. Some pointed to how confidence in the Fed peaked last July, and as confidence in central banks weakens, "FASB 157 will be the least of the worries." Others noted that "mark-to-imagination" is unsustainable and therefore unrealistic over an extended period; and when underlying values emerge, there will be sticker shock.

Still others point to fatigue in risk assets (after a four-year 166% rally), policy (including Obamacare, which disproportionately impacts stockholders (by design) and a "tipping point" on the global stage, when globalization officially flips the switch to isolationism and leaders protect the interests of citizens rather than pander to what they view to be a fading imperialist agenda.

There are a lot of moving parts and many competing agendas, particularly with mutual fund year-end today and the calendar year-end dead ahead. While the story remains untold, I would offer that if the bears have a last gasp in them, it will emerge over the next two weeks. It's a tall order but not an impossible one; their mission in the rain is to drive prices below support at S&P 1730 and Nasdaq (INDEXNASDAQ:NDX) 3255.

Good luck today.

R.P.

Twitter: @todd_harrison

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Position in SPY.

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 todd@minyanville.com.

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