{"id":45885,"date":"2014-01-01T20:18:59","date_gmt":"2014-01-02T01:18:59","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=45885"},"modified":"2014-01-01T20:18:59","modified_gmt":"2014-01-02T01:18:59","slug":"the-federal-reserve-takes-its-foot-off-the-accelerator","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2014\/01\/01\/the-federal-reserve-takes-its-foot-off-the-accelerator\/","title":{"rendered":"The Federal Reserve Takes its Foot off The Accelerator"},"content":{"rendered":"

By MoneyMorning.com.au<\/u><\/a><\/p>\n

The taper has come and gone and the world still turns. Imagine that. The Federal Reserve’s<\/strong> decision to reduce its monthly bond purchases by $10 billion wasn’t a show stopper on Wall Street. It was a show starter.<\/p>\n

The Dow Jones Industrials climbed almost three hundred points and nearly 2%. The S&P 500 went back over 1800. Not to be outdone, the ASX\/200 sighed with relief and climbed over 2% to close above 5,200 again. What’s more, the gold price fell 3.4% in US dollar terms to a three-year low.<\/p>\n

The reporting about the taper shows you how muddled investor thinking has become. For example, one local newspaper reported that since markets rallied after the taper announcement, it suggested that the US economic recovery would not ‘derail’ financial markets. Let’s leave aside the question of whether there really is<\/em> a US recovery. Since when would a recovery in the economy ever derail stock markets? <\/p>\n

If the economy were getting better, why would stocks ever get worse? This is the mental conundrum Fed followers are in. Stimulus in the form of quantitative easing, which is good for stocks<\/a> (especially financial stocks) can only last as long as the economy (where the rest of us live) is bad. Thus, bad news for Main Street is better news for Wall Street.<\/p>\n

What a relief it must have been for traders to realise that good news for Main Street (even if it’s made up) isn’t bad news for Wall Street. That’s what the reaction seemed to indicate. Or, perhaps investors had already priced in the taper and it was more a case of, ‘buy the rumour, sell the fact’. Another possibility is that traders are hell bent on buying stocks <\/a>because it’s a cyclical bull market and any reason will do (or none is necessary). But check out the chart below. <\/p>\n

New Highs on Narrow Breadth<\/h2>\n<\/p>\n

<\/a>
\n Click to enlarge<\/em><\/a> <\/p>\n<\/p>\n

The black line on the chart shows the number of stocks on the S&P 100 in a bullish point-and-figure pattern. The red line is the index itself. The right scale measures the bullish percent figure. The left scale measures the level of the index. What does it tell you?<\/p>\n

Well, the S&P itself has climbed 50% in the last two years. But it hasn’t been a smooth ride. During that run, the bullish percent index has dropped to nearly 50 two times. When it reaches that number it means half the stocks are in a bullish point and figure pattern and half are bearish. Why is this important?<\/p>\n

You can take this chart as a measure of the market’s real health. It’s both a measure of breadth and momentum. Most of the time, those measures are correlated with the trends in the underlying index. Except for now.<\/p>\n

Look closely and you’ll see that this month, the index has made new highs even as breadth deteriorates. Fewer stocks out of the 100 are in bullish patterns. Yet the index keeps climbing. Breadth is deteriorating. This is a classic sign of a market with narrower leadership. More liquidity is piling into a smaller band of blue chip stocks<\/a>. This creates self-fulfilling rallies. But they are not broad rallies. And that makes them fragile. How fragile? Now look at the chart below. <\/p>\n

QE Pumps up American and Japanese stocks<\/h2>\n<\/p>\n

\n <\/a>
\n Click to enlarge<\/em><\/a> <\/p>\n

The S&P 500 is up 165% from the low on March 9, 2009. And yes, I cherry picked that low. It’s what makes the gain so impressive. The 2009 lows were put in because the Federal Reserve<\/strong> committed to providing Wall Street firms with cheap credit to turn into trading profits. It has worked a treat.<\/p>\n

By comparison, Japanese stocks didn’t really get going until the Bank of Japan pledged to double the monetary base in November 2012. It was a late start. But the red line shows it’s been an impressive game of catch up. As I wrote recently, a US dollar rally against the euro could make European shares the next cab off the rank in terms of QE-driven rallies (especially if money comes out of overvalued US stocks and into cheaper European stocks).<\/p>\n

Australian stocks, as measured by the All Ordinaries, are up a respectable 63% since the 2009 lows. But without an ambitious plan of money printing from the RBA, local shares can’t compete with their blue-chip brethren overseas. And even if the RBA does print (unlikely), the weaker Aussie dollar and lower interest rates will erode Australia’s recent reputation as high-yield haven for foreign capital.<\/p>\n

Fragile things break easily. All it takes is a wayward bump. The trouble with a bump like that is that you never see it coming until it’s too late. Stocks could fall by 15-20% in a matter of weeks, both in America and here in Australia. Be ready for that.<\/p>\n

And keep your wits about you. The big takeaway from the Fed’s language recently is that it would keep interest rates low ‘well past the time’ US unemployment hits 6.5%. Interest rates are effectively dead as a tool for conducting monetary policy. That leaves asset purchases.<\/p>\n

But when the Federal Reserve <\/a>purchases government bonds or mortgage backed securities, it doesn’t stimulate the economy in the same way an interest rate cut might. It only stimulates financial markets, which is why they’re making new highs. More importantly, as my mate Greg Canavan pointed out, QE pushes stock prices higher by pushing the equity risk premium lower. <\/p>\n

It’s a dangerous game that always results in investors taking too much risk. They take too much risk because price signals no longer communicate the real level of risk you’re taking in buying an asset or security. Investors become speculators and rush headlong into an increasingly narrow class of assets: stocks and financial stocks especially. <\/p>\n

Poor old Janet Yellen has her work cut out of for her. Ben Bernanke will leave on a high. But the Yellen Fed will have only one tool left to address the next crisis: bigger asset purchases. You can view this week’s taper as the Federal Reserve taking its foot off the accelerator for a moment. But Yellen has a lead foot. There’s danger on the road ahead.<\/p>\n

Best Regards,<\/p>\n

Dan Denning+<\/a>, <\/strong>
\n Contributing Editor, Money Morning<\/em><\/strong><\/p>\n

Ed Note: This article is an edited extract of an update originally published in The Denning Report<\/a><\/em>.<\/p>\n

\nJoin Money Morning on Google+ <\/u><\/a><\/strong><\/p>\n

\n<\/img><\/a> <\/img><\/a> <\/img><\/a>\n<\/div>\n


\nBy MoneyMorning.com.au<\/u><\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

By MoneyMorning.com.au The taper has come and gone and the world still turns. Imagine that. The Federal Reserve’s decision to reduce its monthly bond purchases by $10 billion wasn’t a show stopper on Wall Street. It was a show starter. The Dow Jones Industrials climbed almost three hundred points and nearly 2%. The S&P 500 … <\/p>\n

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