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.
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.
The overdue market correction analysts and pundits have been waiting for may have arrived with the breakdown of the S&P. It has been a two stage process, with Japan breaking first and the U.S. and the rest of the world following suit. One of the interesting aspects of this correction is that bond yields are moving higher as stock prices have been moving lower. In Japan the focus has been on a bond yield rising in a nation with very high debt levels. In the U.S. yields have been going up too, and the buzz has been that the Federal Reserve may start “tapering” down their $85 billion bond buying spree (known as QE Infinity).
One concept that is common in the investment world is the idea that assets will typically revert to the mean or mean reversion (the average). This may seem a bit contrarian since it essentially means that when an asset price returns in excess of its long term average return profile, over time it will likely reverse course and return to that long term average. Imagine a rubber band that gets stretched…. and then eventually snaps back to its normal size.
Just two days ago the 4th quarter GDP came out as a negative number, which was much worse than expected. In fact, not one of 83 analysts had anticipated a negative number, meaning they were all too bullish on the 4th quarter growth number. But yesterday the Chicago Purchasing manager’s index, a growth barometer, was way above expectations for growth, and not one of 48 analyst estimates was in the ballpark, meaning they were all too bearish on growth.
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.