Bring on the US taper

Markets will rally once the unwinding of the US stimulus program gets underway.

Summary: There is a prevailing view that quantitative easing– particularly the US economic stimulus program – is driving global markets. Likewise, many believe that once QE efforts are tapered markets will fall. But any US tapering will confirm that all the major crises of recent times are well behind us, and that should fuel the bull market rally.
Key take-out: Stimulus efforts can be tapered without any significant adverse impact on either the economy or the stockmarket.
Key beneficiaries: General investors. Category: Economics and strategy.

Regular readers will not be surprised by my views here, but I believe I need to go over some of the issues again, for the US ‘taper’ (the plan to pull back on printing money) really is the dominant issue impacting market sentiment at the moment.

May I just at the outset assure you that “tapering”, when it happens, will have negligible, if any, negative impact on the stockmarket. I can understand that many people have different views on this, and mine is simply that … another opinion.

But I believe there are two distinct aspects to what is occurring in this relationship between the economy and quantitative easing, or stimulus as it is more broadly understood, that require consideration.

Firstly, even if the correct view is that the stimulus measures, predominantly quantitative easing, are responsible for the equity markets’ strength, this may still very well turn out to be quite a historic and significant example of, “sell the rumour, buy the fact”! By this, I mean that even if the market “should” move lower because of tapering, this scenario has been so well telegraphed and accepted by the great majority of market participants that everyone will be positioned accordingly well in advance.

This means that all those who are bearish as a result of the prospect of tapering will already be short, well before it occurs. I have spoken before about the process where once everyone who wants to buy, or in this case sell, has done so, then they have without their real awareness of the fact all become nothing but a “sea of potential buyers”. They will need to buy, in order to take profit on their short positions, and there is no one new, or left, to sell afresh. So once tapering actually occurs, the market may at most be priced a little lower for perhaps a day, or for only a few hours, before it again begins to rally. Furthermore, the subsequent rally is likely to accelerate as all those who were positioned short begin to aggressively buy their positions back. They will be competing with one another to do so.

In summary then, even if the market “should” fall due to “tapering”, it is now unlikely to do so!

Secondly, fundamentally I do not believe the market “should” fall.

In fact, I believe the exact opposite, which is that the market should be looking to “tapering” as confirmation that all the major crises of recent times are well behind us, and if I may say, economically the good times are back.

The market should celebrate tapering!

The Federal Reserve has made it abundantly clear on numerous occasions that it will only begin tapering when the economy is on a robust and stable footing, that will sustain continued firm economic growth near or above trend. It is quite obvious then, that tapering only ever begins, when things are rather good; that is, when the economy is very strong.

Given the Federal Reserve is one of the more conservative institutions in the world, and the depth of the crises that have been faced in recent years, it has only ever been the case that the Fed would err on the side of caution. I believe this is exactly what is happening. The stimulus measures are going on for longer than necessary. With too much stimulus in the system, and the economy having continued to improve to the level of robust expansion, it becomes abundantly clear that the stockmarket would therefore be likely to react by accelerating.

On the basis of the above two points, the true risk then from “tapering”, is that the stock market will accelerate higher, not decline.

There is even more to suggest that the market can take tapering in its stride. The stockmarket has been in a bull market, one I named a new “Grand Bull Market”, since March 2009. In fact, 2009 was the biggest stockmarket rally in the last decade. One of the reasons the rally was as aggressive as I thought it would be at the time was because, just like now, everyone was taking one view on the market and it was a view not justified by the fundamental facts.

A strong economy, and tapering, only occurs in a strong economic environment. In turn, that means increased revenues and profits for businesses, which of course means their stock prices are likely to move higher. The bears are actually suggesting you should sell good American companies because their profits will be sound and increasing?

Yet further, I would suggest that the bull market we have seen has had little to do with the stimulus measures, and has had a great deal more to do with the strength of the new capitalist economies of Asia and Latin America. It is their growth and trade with each other that is enriching their own societies and certainly contributing to the wealth and success of S&P top 500 companies. The rest of the world, apart from Europe, remained relatively strong throughout the GFC and the sovereign debt crisis. This more robust global economy that has now come of age is able to cope with the swings and roundabouts of the US economy and therefore helps to stabilise global and indeed US equity markets.

We live in a new and prosperous age, and that is why stimulus is unnecessary and can be tapered, without any significant adverse impact on either the economy or the stockmarket.

Then there is the timing and the nature of “tapering”. With Janet Yellen taking the helm at the Federal Reserve from Ben Bernanke we are likely to see an earlier adoption of tapering, I believe, commencing in January or February, but for the process to be more gentle and drawn out over the whole of 2014.

My price action prognosis is that the stockmarket will now rally significantly into December/January, pause for the advent of “tapering”, then accelerate through much of 2014 in parallel with the occurrence of “tapering”. In 2009 I forecast the stockmarket would rally in parallel with high unemployment and a depressed home construction industry. Now, they were “real” fundamental weights that the market did indeed overcome. Tapering is not such a challenge.

In a nutshell, we should all keep buying this and any other dip that comes our way. It is, after all, a Grand Bull Market!


Clifford Bennett is chief economist at Investor Unity. www.IU.com.au/UP