The Market Is Freaking Out Over The Fed

Includes: GE, GLD, MMM, PG, SLV, SPY, VXX, WMT
by: Quoth the Raven

The Federal Reserve came out of temporary hibernation on Wednesday, long enough to suggest that it is not going to be tapering off bond buying anytime soon. The Fed noted that it's been watching the economy grow well, and that it plans to keep interest rates low and will continue to buy $85 billion in bonds per month. Good news for bulls, right? Not necessarily - and the market didn't seem to think so, either.

It was previously argued by me that the time when the smart money fails to respond or following directly in the footsteps of the Fed's decision making, that we're going to see catastrophe for the markets.

In a recent article, "Make The Right Moves When the Fed Stops QE," I said the following:

Despite comments made by Jim Cramer last week, I contend that there is a direct correlation between how often and when the Fed injects money into the economy and the state of the global markets. The Federal Reserve has been the ultimate kind of insurance for people looking to go long in the market - essentially an entity that can prevent the market from heading to a recession whenever it wants. No wonder everyone is throwing as much money as they possibly can find into stocks right now; we're betting with the house, and so far in the Keynesian era, the house always seems to win. It almost seems like the perfect crime, and it reminds me of every time as a child when my mother said to me "If something seems too good to be true, it probably is."

It's going to likely be extremely catastrophic when the day comes (in the not-too-distant future, in my opinion) when QE actually ceases to make an effect on the market. That's when we'll have reached the top of the QE parabola, and are going to experience a downside that'll make the housing bubble burst look minor in comparison.

There is no doubt about it - at some point the general public will lose faith in QE, see it as a crutch, and will subject itself to wicked consequences.

The purpose of this article is to put forth the argument that the market response we saw today could be one of the primary foreshadowing indicators that the Fed's easing could be losing its traction. Or, even likelier, that no matter what the Fed is doing currently, one of two situations will occur that are going to result in the market pulling back anyway. I'll cover those a bit later on.

A quick note here - bulls will be quick to point out my track record here, which I'll admit hasn't been the greatest over the short term when speaking about my macro view on the market and/or the Federal Reserve.

On March 12, with the market sitting right around 14,500, I argued that for all intents and purposes, we were at the end of the bull market. Let the record show that I'm not necessarily wrong - yet - as the market has risen a little, but has been condensing steadily since then.

On April 16, I made the argument that the market is on the verge of panic. I still believe this to be true - the volatility and uncertainty during this latest few weeks of condensing has been palpable.

In the long term, however, I'm contending that my argument still holds water. I'm still a firm believer that there is going to come a point where, as QE continues to run, the public is going to lose confidence and it's going to crush the market.

Here's what the Fed, people who follow and support it, and "smart money" (read: rich people that control the markets) think QE and the market's should work like (pay no attention to the numbers, just the trends):

And here's how I've contested that things are going to eventually go. You can ignore the actual data, as it's mostly made up - what I want you to focus on here is the relationship to confidence coming down while QE is in full force; and how much of a hit to the market it would be for the Fed to lower QE while we've already lost confidence in the market.

The key would be to loosen things up now; when the market is at its bullish and most confident sentiment. Instead, with the Fed saying it is going to continue until it feels certain points are met with both the economy and unemployment, it's just blowing the bubble up even further. reported today:

Interestingly, the language in the statement provides a mulligan on the recent 'tapering' comments. But Wall Street has already 'traded out' those statements and bulls will now focus on the comments about the likelihood of an increase in rates not occurring until 2015. Keeping rates low indicates a continued bull run in equities for the foreseeable future.

The policymakers also reiterated that the unemployment rate remained too high, supporting their decision to keep purchasing assets until the outlook for jobs improves, but offered a slightly rosier assessment of the balance of risks to the nation's growth.

Fourteen of the 19 Fed members said they did not think it would be appropriate to raise rates until some time in 2015.

What happened today as soon as the Fed made the announcement that it was going to continue QE for the foreseeable future? Take a look at this intra-day chart of Wednesday's trading:

The market absolutely cannot seem to make up its mind on how it wants to read this data. If I worked for CNBC, the end of the day headline would be "Stock Market FREAKS OUT Over Fed Speech." It's almost as if the market may have been expecting a pullback on QE. We are having knee-jerk movement both upwards and downwards to end the trading day. What could the possible explanation be for this - euphoria that QE isn't totally finished? People starting to head for the exits? What the hell is going on?

It was then reported later in the day on Wednesday that the Fed again alluded to wrapping up QE in 2013 and being finished totally in 2014.

At a news conference, the central bank chief said if the economy continues to improve the asset-purchasing program could start winding down towards the end of 2013 and wrap up in 2014.

So, it looks like one way or another we are heading for a definite pullback. Here's the two ways it can happen, in my opinion:

Bad: Assuming the economy hits the parameters that the Fed has set to start "tapering." The Fed starts to taper in 2013, heading into 2014, as it has previously stated.

Worse: The Fed continues QE "until certain parameters" are met (i.e. it waits for things to get a little better and the unemployment rate to get where it wants). Before this occurs, the market loses confidence in QE and the market suffers some semi-violent whiplash.

Mega-Worse: "Certain parameters" aren't ever met (or met anytime soon), yet the Fed decides to continue easing anyway. Eventual confidence goes low while QE stays at full force. Market winds up absolutely thrashed.

Call me a doomsday conspiracy theorist, but there's never been a better time for me to reiterate and back up my bearish sentiments on how to position yourself than now.

In my previous article "Are You Ready for the Fed to Move the Market?" I offered up three different potential positions on how you could position yourself according to today's news. Today, I want to tell you exactly how I would position myself after today's news.

My portfolio for this situation would be similar to my "end of the world" portfolio that I laid out in a previous article. The portfolio would include any or all of the following:

  • Small 5%-10% long position in staple stocks like (PG, MMM, GE, WMT)
  • Medium-sized position in actual gold or silver bullion, and small long positions in gold and silver trusts (GLD, SLV)
  • Medium-sized cash position in FDIC insured account (or several FDIC insured accounts) or in person
  • Small position in volatility ETFs and ETNs (like VXX) to be traded in the very short term. If the VIX winds up going ape-crap, VXX will track it (at least in the short term - be wary of long-term contango and time decay with VXX).
  • Medium-sized long positions in inflation-adjusted Treasuries (AAA rated)

I'll take this time to again remind my readers that I'm a bit more bullish on silver versus gold, due to the fact that its correlation with gold is out of whack right now and that silver is held not only as a reserve metal, but is also used in manufacturing.

One thing is for sure, I'll be watching the end of 2013 to see how Ben decides to wrap things up - in the rare case he hikes up his skirt and does what he's alluding to. As always, best of luck to all investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.