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David Moenning is a the proprietor of StateoftheMarkets.com. In addition to providing free and subscription-based portfolios on "State", Dave is a full-time money manager and the President and Chief Investment Strategist of a Chicago-based Registered Investment Advisory firm. Dave... More
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  • Lesson From The Fed: ZIRP Trumps Taper 0 comments
    Dec 19, 2013 7:59 AM

    Daily State of the Markets
    Thursday, December 19, 2013

    For weeks, the question of whether or not the Fed would begin tapering their QE program was the focus of the stock market. After each and every economic report, the issue was always the same: Was good news bad for stocks because it meant the Fed would start pulling the punch bowl? Or was good news actually good because it meant that the economy was improving?

    In reality, both arguments have merit. So, as far as the stock market has been concerned, Goldilocks became the desired outcome for most economic reports. The hope was that the data wasn't so strong that it would encourage the Fed to take action or weak enough to create worry about the economy slipping into recession.

    So, going into the all-important FOMC meeting yesterday, the general consensus was that if the Fed decided it was time to taper back their bond buying program, stocks would fall. And if the committee deemed the economy weak enough to continue to need the FOMC's full support, stocks would rise.

    Wait, Does That Even Make Sense?

    To be sure, this line of thinking is more than a little convoluted. Shouldn't everyone in the good 'ol USofA be rooting for the economy to improve?

    At issue here is the idea of global liquidity. With the central banks of the world flooding the financial system with cash (the U.S. and Japanese central bankers alone are pumping out nearly $2 trillion a year), the bottom line is that newly minted money has to go somewhere. And over the past year, an awful lot of that cash has found its way into the U.S. stock market. Thus, the worry is that if the Fed stops the printing press, demand for stocks could decline.

    Then there is the "carry trade." If you are a big - really big - institution, the Fed's ZIRP (Zero Interest Rate Policy) means that you can borrow at 0% and invest that money. So, yes Virginia, there is indeed a free lunch available if you're the size of Goldman, JPMorgan, Citadel, etc.

    Wasn't The Taper Supposed to be Bad?

    So... when the FOMC announced that it would begin reducing their monthly bond purchases from $85 billion a month to $75 billion a month, most investors probably thought the stock market would tank. And in fact, it did - for exactly one minute.

    Yep, that's right; the minute after the statement was released, the S&P 500 plunged from about 1780 to 1768. The algos saw the word "taper" and did what they were programmed to do - sell, quickly.

    The Algos Got It Wrong (Again)

    However, the next minute the market spiked higher. And in the ensuing 7 minutes, the S&P soared from 1768 to 1795, a move of 1.5 percent. So, in 8 minutes, the algos moved S&P 500 39 points. What the heck?

    Turns out that there was more to the FOMC statement than the taper. Obviously the taper announcement was bad. But the rest of the story was actually better than almost anyone had imagined. And it turns out that traders and their algos liked it - a lot!

    The Press Really Got It Wrong (Again)

    The headlines read, "Stocks soar on Fed Taper." Uh, no. Stocks tanked on the taper.

    But, what the popular press didn't seem to get was the fact that the FOMC had basically said that ZIRP will stick around longer than expected and that inflation is now the key thing the Fed is concerned with - not employment.

    So, in essence, Ben Bernanke was trading a "taper light" for an extension of the Zero Interest Rate period. This meant that monetary policy was actually going to stay easy LONGER than had been anticipated. Oh, and it also appeared that Bernanke was changing the trigger for future rate increases more toward inflation.

    Here's the actual line from the FOMC statement: "The Committee now anticipates...that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal."

    So, as long as inflation remains under 2 percent, the Fed now appears to have cover to keep rates at zero. Boom-shakalaka!

    The new emphasis on inflation is big. Why? Because, if one digs into the guts of CPI, they will find that wage inflation is what really drives up the official rate of inflation. And anyone who works for a living knows that there aren't a lot of raises being tossed around these days. As such, unless the job market picks up in a big way, rates can likely stay low longer by focusing on inflation.

    What Mr. Bernanke is really saying is that the Unemployment Rate isn't telling the true story of the jobs market. So, by shifting the focus to inflation, the Fed can continue to lend a hand until the much sought after "escape velocity" is actually reached.

    So, what did we learn from Mr. Bernanke's last go round? In short, that ZIRP is more important than "the taper." And since low rates - especially uber-low rates - are good for stocks and may be around for quite some time yet, stocks celebrated. Well, okay, the algos took out the shorts and then the trend following algos piled on. But regardless of the reason, the key is anyone long stocks yesterday probably enjoyed the ride.

    Looking for a disciplined approach to managing stock market risk on a daily basis? Check Out My "Daily Decision" System. Forget the fast money and the latest, greatest option trade. What investors need is a strategy to keep them "in" the stock market during bull markets and on the sidelines (or short) during bear markets.

    Turning to This Morning...

    Now that the Fed decision is out of the way, traders in the U.S. may be looking for something else to focus on. As such, it will be very interesting to see what the focus becomes. Overnight, Chinese stocks fell for an eighth straight session while European bourses are following Wall Street's lead higher at the present time. Here at home, U.S. futures are little changed but gold is getting slammed and rates are rising (something to watch).

    Pre-Game Indicators

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

    Major Foreign Markets:
    - Japan: +1.74%
    - Hong Kong: -1.10%
    - Shanghai: -0.94%
    - London: +1.03%
    - Germany: +1.29%
    - France: +1.13%
    - Italy: +1.39%
    - Spain: +1.55%

    Crude Oil Futures: +$0.01 to $97.81

    Gold: -$30.70 to $1204.30

    Dollar: higher against the yen, euro and pound.

    10-Year Bond Yield: Currently trading at 2.911%

    Stock Futures Ahead of Open in U.S. (relative to fair value):
    - S&P 500: +1.45
    - Dow Jones Industrial Average: +16
    - NASDAQ Composite: -1.18

    Thought For The Day...

    Look at everything as though you were seeing it either for the first or last time. -Betty Smith

    Positions in stocks mentioned: none

    Follow Me on Twitter: @StateDave


    The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning's opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

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    The analysis provided is based on both technical and fundamental research and is provided "as is" without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

    The information contained in this report is provided by Ridge Publishing Co. Inc. (Ridge). One of the principals of Ridge, Mr. David Moenning, is also President and majority shareholder of Heritage Capital Management, Inc. (NASDAQ:HCM) a Chicago-based money management firm. HCM is registered as an investment adviser. HCM also serves as a sub-advisor to other investment advisory firms. Ridge is a publisher and has not registered as an investment adviser. Neither HCM nor Ridge is registered as a broker-dealer.

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