To Taper or Not to Taper: That Is the Question

Federal Reserve

It’s not Hamlet who is providing theatrical intrigue in the financial markets, but rather Federal Reserve Chair Ben Bernanke. Watching Bernanke decide whether to taper or not to taper the $85 billion in monthly bond purchases (quantitative easing) is similar to viewing an emotionally volatile Shakespearean drama.

The audience of investors is at the edge of their seats waiting to see if incoming Fed Chief will be plagued with guilt like Lady Macbeth for her complicit money printing ways — or will she score a heroic and triumphant victory for her hawkish stance on quantitative easing (QE). No need to purchase tickets at a theater box office near you, because the performance is coming live to your living room as Yellen’s upcoming Senate confirmation hearings will be televised this upcoming week.

Bad News = Good News; Good News = Bad News?

In deciding whether to slowly kill QE, the Fed has been stricken with the usual stream of never-ending economic data (see current data from Barry Ritholtz). Most recently, investors have followed the script that says bad news is good news for stocks and good news is bad news. So-called pundits, strategists, and economists generally believe sluggish economic data will lead the Fed to further romance QE for a longer period, while robust data will force a poisonous death to QE via tapering.

Good News

Despite the recent, tragically-perceived government shutdown, here is the week’s positive news that may contribute to an accelerated QE stimulus tapering:

  • Strong Jobs: The latest monthly employment report showed +204,000 jobs added in October, almost +100,000 more additions than economists expected.  August and September job additions were also revised higher.
  • GDP Surprise: Third-quarter GDP registered in at +2.8% versus expectations of 2 percent.
  • IPO Dough: Twitter Inc. (NYSE:TWTR) achieved a lofty $25,000,000,000 initial public offering (IPO) value on its first day of trading.
  • ECB Cuts Rates: The European Central Bank (NYSE:ECB) lowered its key benchmark refinancing rate to a record low 0.25 percent level.
  • Service Sector Surge: ISM non-manufacturing PMI data for October came in at 55.4 versus 54.0 estimate.

Bad News

Here is the other side of the coin, which could assist in the delay of tapering:

  • Mortgage Apps Decline:  Last week the MBA mortgage application index fell -7 percent.
  • Jobless # Revised Higher: Last week’s Initial jobless Claims were revised higher by 5,000 to 345,000.
  • Investors Too Happy: The spread between Bulls & Bears is highest since April 2011 as measured by Investors Intelligence.

 

Much Ado About Nothing

With the recent surge in the October jobs numbers, the tapering plot has thickened. But rather than a tragic death to the stock market, the inevitable taper and eventual tightening of the Fed Funds rate will likely be Much Ado About Nothing. How can that be? As I have written in an article earlier this year (see 1994 Bond Repeat), the modest increase in 2013 yields (up +1.35 percent approximately) from the July 2012 lows pales in comparison to the +2.5 percent multi-period hike in the 1994 Federal Funds rate by then Fed Chair Alan Greenspan. What’s more, inflation was a much greater risk in 1994 with GDP exceeding 4.0 percent and unemployment reaching a hot 5.5 percent level.

Given an overheated economy and job market in 1994, coupled with a hawkish Fed aggressively raising rates, the impact of these factors must have been disastrous for the stock market, right? Wrong. The S&P 500 actually finished the year essentially flat (~-1.5 percent) after experiencing some volatility earlier in the year, then subsequently stocks went on a tear to more than triple in value over the next five years.

To taper or not to taper may be the media question du jour, however, the Fed’s ultimate decision regarding QE will most likely resemble a heroic Shakespearean finale or Much Ado About Nothing. Panicked portfolios may be in love with cash like Romeo & Juliet were with each other, but overreaction by investors to future tapering and rate hikes may result in poisonous or tragic returns.

Wade Slome, CFA CFP is President and Founder of Sidoxia Capital Management and shares his investing insights at Investing Caffeine.

Don’t Miss: Obama Recognizes Fumbles, Makes Changes to Stay in the Game.