Last week's release of the latest Fed minutes was nothing short of an experiment to see how the markets would respond to the curtailing of Quantitative Easing. By all accounts, it didn't go very well.
The minutes were very clear in its discussion of the future pace of the Fed's (currently) $85 billion per month asset purchases:
"A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome."
In common language, "The Fed is thinking about reducing the size of asset purchases starting in June." Whether they do or not is immaterial; what matters is that the Fed is starting to prepare the markets for this inevitability to see how participants will react. Immediately following this announcement last Wednesday (5/22) ALL at-risk asset classes fell sharply: U.S. equities (SPY) (QQQ) (DIA) (IWN) (IWO), foreign markets (EEM (VWO), commodities (GLD) (OIL) (SLV) (JJC) real estate (IYR), AND fixed income (TLT).
This is bad news.
Has QE1 and 2 really resulted in nearly all asset classes now being correlated? If so, it may be reasonable to assume that much - if not all - of the market rebound has been due to accounting gimmicks and the promise of future, unending stimulus. The market reaction says as much.
But the inclusion of fixed income assets in this extensive list should make all investors who are pay close attention. Because if fixed income has now become correlated to risk assets, it becomes a de-facto risk asset itself, which will throw the basic idea of diversification out the window. So much for modern portfolio theory.