Wednesday’s Federal Reserve meeting was a bit of a shocker to the markets. Since the summer, it appeared that the Fed had laid the groundwork for the reduction of asset purchases, and the market certainly expected something like that coming into yesterday’s meeting. When Ben Bernanke declined to taper purchases — and took a dovish tone in the press conference that ensued — markets made immediate adjustments. By the end of the day, stocks were up big, as were bonds; but the U.S. dollar hated the thought of the Fed keeping its foot on the gas pedal.
Inflection Point: (N) – Mathematics – A point on a curve at which the curvature changes from convex to concave or vice versa.
In describing our current thinking, I have to resort to an investment writing cliché where the financial markets are described as being “at an inflection point.” While the mathematical definition for an inflection point is presented above, in the business of investing inflection points occur where there is a change in the long-term trend or momentum of the financial markets, economy, or price of an individual security. Inflection points are critically important because if you recognize one and if you understand the significance of the change, then you can make a lot of money.
Markets are continuing to react and adjust, mostly in a negative manner, to the Federal Reserve’s announcement about their intention to wind down their quantitative easing program later this year. Volatility, as it is known to do, popped back up in fairly short order after a steady decline through the first five months of the year. The S&P 500 Index is now off by more than -5% from its high on May 21, and interest rates on the 10-Year U.S. Treasury are high by almost 1% from their low on May 2nd. While corrections and pullbacks are always unsettling, the moves so far in the U.S. have been fairly run of the mill. After all, the S&P is still up more than 10% on the year, and bonds, at 2.58%, are still at extraordinarily low levels.
Today you’ll hear the term ‘triple witching’ a lot in the media — it refers to four Fridays a year when stock index futures, stock index options, and stock options all expire on the same day. The expiration can lead to unusual volatility in markets as traders scramble to offset positions. This could make things quite bumpy, but I think there may be a more important triple witch – one that has provided the catalyst for a deep correction in U.S. markets.
It’s that time of year when everyone gets excited for their hoped-for tax refund. But should we really be celebrating?
One of my favorite scenes in the Pixar movie Finding Nemo comes at the end. The fish had managed to outwit the Dentist (who was holding them captive in a tank) by dirtying the water enough to force a water change. In order to do that, the Dentist had to bag the fish and leave them outside the tank, at which point they jumped out the window and into the harbor below. Unfortunately, they hadn’t considered how they were going to get out of the plastic bags. The movie ends with one of the fish asking, “Now what?”
The Federal Reserve spoke yesterday, and not surprisingly decided to buy more treasury bonds to keep expanding the balance sheet. It might have been a bit surprising that they have now also explicitly targeted an improvement in the unemployment rate (6.5%) and stated a tolerable inflation band (2.5%) for investors to use as guides for when the Fed might engage in policy withdrawal. The market went up for a few hours, and then drifted back to earth and closed unchanged on the day; Fed decisions can’t force politicians to trade in political theatre and come up with a deal before the 11th hour.
Everybody knows that the dice are loaded.
Everybody rolls with their fingers crossed.
Everybody knows that the war is over.
Everybody knows the good guys lost.
Everybody knows the fight was fixed.
The poor stay poor, the rich get rich.
That’s how it goes,
Leonard Cohen, “Everybody Knows”
Right now we sit in an unusual place in financial history: World fundamentals are taking a back seat to policy makers who are defending the current system with new monetary tools. As market analysts, we’ve watched the perpetual bull and bear debate grow as divisive as ever, and while both camps have impressive arguments, neither camp has enough history to make their case.
Mr. Mojo Risin’, got to keep on risin’.
The Doors, “L.A. Woman”