Sustainable, But Not Normal Yet
The taper surprise was that stocks rocketed higher once the markets digested the Fed's statement. The market chose to focus on the improving economy rather than a reduction in monetary stimulus. From The Wall Street Journal:
"Today's policy actions reflect the [Fed's] assessment that the economy is continuing to make progress, but that it also has much farther to travel before conditions can be judged normal," Mr. Bernanke said. Beth Ann Bovino, chief U.S. economist at the bond-rating firm Standard & Poor's, said in a note to clients after the decision, "Today's decision by the Fed is a vote of confidence in the sustainability of the economic recovery." She pointed to a batch of stronger economic reports for October and November, in addition to reduced political uncertainty.
Stock Market Held Near Logical Support
It was a wild ride after the release of the Fed's latest policy statement. The S&P 500 initially reacted to the term "taper" and dropped 13 points below Tuesday's closing price. The taper sell-off was short-lived as investors began to focus on the glass-half-full side of the argument, or an improving economic outlook. In the end, the economic bulls carried the day with the S&P 500 finishing 42 points off the post Fed announcement low. The broader NYSE Composite Index also attracted buyers at a logical level (see chart below).
Low Rates Even When Unemployment Falls
Part of the market's ability to digest the taper news in a somewhat surprising bullish manner, was the Fed's emphasis on keeping interest rates low for an extended period. From Bloomberg:
Homebuilders rallied after the Fed said it may hold interest rates near zero even if unemployment falls below the 6.5 percent rate the central bank previously cited as a likely catalyst for an increase.
Buyers Push S&P 500 To New Closing High
When markets push to new highs, they can often attract buyers that have been waiting to see if overhead resistance holds. The bullish conviction was strong enough Wednesday afternoon to push the S&P 500 to a new closing high. As we noted on December 4, stock market corrections are often preceded by a discernible lower high on a weekly chart (see A and B below). If the S&P 500 can carry Wednesday's strength through the end of the week, it would take the lower high concern off the table.
Investment Implications - Still Long
Our market model called for a reduction of risk last week, but bearish economic conviction did not reach levels calling for significant defensive action. As we tweeted last week, incremental moves do not mean 100% cash or ready to short.
Below is an except from Tuesday's post concerning our Fed announcement strategy:
Even if we had Wednesday's Fed statement in hand, it would not be as helpful as you might think. Why? We still would not know the market's reaction to the statement. Since the market sets asset prices, the reaction is much more important than the statement itself. Therefore, our game plan is to see how things unfold over the next few days and adjust accordingly.
Being patient with our long positions has paid off (so far). The bullish comparisons to 2000 and 2007 in this video clip still apply to the present day market. We continue to hold stakes in U.S. stocks (NYSEARCA:VTI), technology (NASDAQ:QQQ), financials (NYSEARCA:XLF), energy (NYSEARCA:XLE), small caps (NYSEARCA:IWM), emerging markets (NYSEARCA:EEM), and foreign stocks (NYSEARCA:EFA). If the post-Fed gains can see some follow-through in the next two sessions, our model will most likely call for some redeployment of our money market funds. Regular readers have stepped up in a big way showing their support in the "who taught you the most, shared the most useful information" poll. Polls close Thursday at 7 p.m. EST and your vote is greatly appreciated. You can cast your ballot here.
Disclosure: I am long SPY, VTI, XLE, XLY, IWM, FEZ, EEM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.