Every week economic data surprises in one direction or the other. As of late (late being the last 14 months or so), the market often times re-acts in a manner that is contradictory to what would be expected… why?
Economic reports offer us insight into the direction of the economy. When we receive upbeat data regarding employment, wage earnings, retail sales, manufacturing, etc. it sends a clear message of economic expansion; corporate earnings should follow and stocks would be in demand.
After the financial crisis of 2008 the Federal Reserve Board (FRB) implemented a serious of bond buying programs referred to as Quantitative Easing (QE). The purpose of these programs were to keep interest rates low, creating consumption (Homes, Autos, and business investments), and feeding investments as an alternative to low yielding cash. It was successful in its mission by many measures and has resulted in a consumption based expansion that has lasted 5 years.
Over the last 12 months the FRB has made it very clear that the open ended stimulus was going to come to a close. It’s not a tightening of monetary policy, but the FRB is trying to reduce the amount it’s aiding the current expansion. Another way to look at it is that the economy had a broken leg and we used the FRB as a crutch over the last few years. They’re trying to tell us that we don’t need the crutch anymore.
Ever since the announcement last spring that the FRB was eyeing when they would start reducing their bond buying program, affectionately called ‘Tapering’, stocks have behaved contradictory to typical behavior. The FRB keeps a close eye on economic data and as it improves it supports their claim that our economy no longer needs their crutch. If the data is weaker than anticipated it calls into question the strength of the expansion and prolong QE. The strength of the economy then determines the FRB’s subsequent action or inaction.
If the Market fears that the economy is strengthening it sells off in anticipation of tighter FRB policy in the future. If economic data is weaker than expected the Market buys in hopes of prolonged FRB inaction. Exactly the opposite of what the economic indicators would lead you to assume.
The FRB began ‘Tapering’ in January and has taught us to walk a little better every month since then. As we get to a point where QE is not a part of our economic landscape we should see the Fed Effect become eliminated and replaced with concerns over actual timing of FRB tightening policies such as raising interest rates.
As of now, that seems to be anchored well into next year. The predominant estimation is June to July of 2015, however the FRB has made it painfully clear that a weaker or stronger economy in the meantime will impact rates, not a set time table.
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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long term holding strategy is the best strategy in any market environment. Any and all third-party posts or responses to this blog do not reflect the views of the firm and have not been reviewed by the firm for completeness or accuracy.