Daily State Of The Markets: Is The Taper Priced In?

 |  Includes: DIA, SPY
by: David Moenning

Depending on your point of view, stocks appear to be set up to either (a) break out to new highs after today's Fed announcement or (b) dive back into what would then be a very defined trading range. While the consensus among analysts is that Ben Bernanke will announce a "tapering" of the Fed's QEIII program tomorrow, it is interesting to note that the S&P 500 is now positioned right at its all-time highs in front of the announcement. Interesting indeed.

In order to try and ascertain which team might have an edge here BEFORE Ben Bernanke embarks on the last press conference of his Fed career, we thought it might be a good idea to look back at how we got here. In other words, there might be some value in trying to understand why stocks have been moving coming into today's big event.

How Did We Get Here?

If you will recall, a good portion of the blame for the pullback seen in the stock market this summer was attributed to the "taper tantrum." In short, upon hearing Ben Bernanke mention the possibility of the Fed starting to pull back on its stimulus programs, traders immediately equated the idea to the Fed changing its tune. As a result, stock and bond prices sold off as yields began to move up in earnest.

However, after a painstaking communication campaign by Fed officials, which included both inflation hawks and economic doves, traders finally got the message that starting to remove a small portion of the stimulus being provided to the economy was not the same as the Fed raising rates. However, not before the "taper tantrum" had knocked nearly 6 percent off of the S&P 500 and the yield on the 10-year had spiked more than 1 percent.

Part of the Fed's pitch to the markets was the idea that interest rates would continue to stay low for some time. It was communicated that (a) the FOMC would basically never sell some of the mortgage-backed securities it held in its coffers and (b) a fair amount of time would elapse between the end of the current QE program and any actual hiking of rates. As such, the fear of a rate debacle was taken off the table. And the next thing you knew, the stock market indices were making fresh all-time highs.

Stocks then succumbed to another minor sell-off, which amounted to a decline of 4.63 percent over about four weeks. But this time the concern wasn't so much about the Fed, but rather the potential for an armed conflict in the Middle East. Such an event would mean higher oil prices, a pause in economic activity, etc. Regardless of the reason, the price action got ugly for a while and the bears smelled blood.

But as has been the case all year, the pullback ended almost as quickly as it began after it became obvious that Obama had no backing for what could be considered a politically-induced strike against Syria. And after Larry Summers announced that he was no longer interested in Bernanke's job, once again, the S&P 500 finds itself very close to all-time highs.

It is also interesting to note that stocks are back to the high-water mark despite the massive move seen in interest rates. Remember, on May 3, 2013, the yield on the 10-year closed at 1.631%. But as of September 5, that yield had moved up to 2.98%. Thus, investors should take note that although there were definitely some bumps along the way, stocks have been able to head in the same direction as interest rates since Bernanke started talking taper.

So, despite rates nearly doubling, mixed economic performance both home and abroad, the threat of war, the uncertainty over who will be Ben Bernanke's successor, and the expectations that the Fed is going to begin doing its taper dance this afternoon, stocks are sitting at or very near all-time highs. Some will argue that this action means traders are not afraid of "the taper." And if one is being objective, it is hard to argue that this action isn't bullish.

Great Expectations

In terms of what to expect from the Fed meeting today, the general consensus is that the FOMC will indeed begin to "taper" their bond purchase program (aka QEIII) at the conclusion of the meeting. In addition, it is expected that Bernanke will announce cutbacks of between 10 billion and 15 billion dollars. In terms of what the Fed will stop buying, this area is a little less clear. However, since the Treasury market is the most liquid part of the bond market and mortgage-backed securities are more impactful on the housing market, it is anticipated that the Fed will begin tapering its purchase of treasuries.

So, how will the market react? This, of course, is the 64,000 dollar question. Everyone knows that stocks tend to be uber-volatile after FOMC meetings, so don't be surprised if the Dow gains or loses (or both) 100 points in short order. And most traders know that the first move off a Fed meeting is the false move. It is where the market ends the day and how it reacts the following day that will matter.

As was discussed in the opening line this morning, the likelihood is that stocks will either break out to fresh all-time highs or dive back into a trading range. However, the good news is that it is fairly easy to come up with a trading strategy based on either outcome.

Turning to This Morning ...

As expected, there is not a great deal of movement in global markets in front of the Fed's announcement scheduled for this afternoon. All eyes will be on the FOMC as they finally tell us their decision on the topic of tapering the current stimulus program known as QEIII. European stocks are firm in the early going and U.S. stock futures are pointing to a slightly higher open.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell ...

Major Foreign Markets:

- Japan: +1.35%

- Hong Kong: -0.27%

- Shanghai: +0.29%

- London: +0.13%

- Germany: +0.47%

- France: +0.54%

- Italy: +0.62%

- Spain: +0.62%

Crude Oil Futures: +$0.57 to $105.99

Gold: -$7.60 to $1301.80

Dollar: higher against the yen and euro, lower vs pound.

10-Year Bond Yield: Currently trading at 2.863%

Stock Futures Ahead of Open in U.S. (relative to fair value):

- S&P 500: +2.59

- Dow Jones Industrial Average: +29

- NASDAQ Composite: +9.42

Thought For The Day ...

"I think a hero is an ordinary individual who finds strength to persevere & endure in spite of overwhelming obstacles." -- Christopher Reeve

Positions in stocks mentioned: none