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You Won't Believe What Happens When The Fed Starts Tapering

You Won't Believe What Happens When the Fed Starts Tapering by Market Authority

Guess what happens when the Fed starts tapering its purchases of $85bln/ month in Treasuries and Mortgages?

NOTHING!

That's right- NOTHING is going to change.

Now before you call me a heretic for challenging the irrefutable dogma that the market MUST pull back because the Fed starts tapering, let me explain why the common narrative that taper = selloff is most likely wrong.

The financial media loves to push the scary narrative that a selloff is lurking around the corner. These stories drive TV ratings and sell magazines. However, they also prepare investors for the unexpected. And when investors are prepared for something, it very rarely goes that way.

Think about other scary narratives we've heard in the past year- fiscal cliff, sequestration, debt ceiling, etc. Is the market higher or lower? Do you think this time will be different?

Taper Chart SP500

The average investor uses what Oaktree's Howard Marks likes to call, "First-level thinking". In Howard's must-read investment book, The Most Important Thing, he distinguishes between First-level and Second-level thinking. Here are a few examples:

First-level thinking says, "It's a good company, let's buy the stock". Second-level thinking says, "It's a good company, but everyone thinks it's a great company, and it's not. So the stock's overrated and overpriced; let's sell.

First-level thinking says, "The outlook calls for low growth and rising inflation. Let's dump our stocks." Second-level thinking says, "The outlook stinks, but everyone else is selling in panic. Buy!

So let's apply First-level and Second-level thinking to the current scenario:

First-level thinking says, "The Fed is buying assets and that's why prices are going up. When they stop buying prices will go down."

Second-level thinking says, "The Fed is only tapering asset purchases because the economy has gotten significantly better."

Even if the Fed pulls back on its purchases by $5- $10 billion a month, the credit is already starting to flow through the system and this is what drives economic growth. Today we have news that US Corporate Bond issuance set an annual record of $1.48TRLN, which means corporate balance sheets are replete with cash. And when companies are stuffed with cash, they find ways to spend it!

Taper Chart Cashing In

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