Why the QE Tapper Matters.

Stocks have gone up with the Fed’s balance sheet, so what happens when the latter is no longer the case?

There are a lot of things that don’t really matter to the markets much of the time.  A short list:

• Geopolitical – the world is always fighting somewhere
• Congress – do they ever get along?
• Data Points – trends > one piece of data
• Analyst Targets – no idea how any of these can be accurate

Not that any of those can’t ultimately change the markets, but I can’t think of a logical reason to sell because country X on the other side of the world might invade country Y on the side of the world.  How does that matter to the US again?

Anyway, I digress.  One thing I do think matters is the quantitative easing tapering (QE).  QE is when the Fed buys longer-term Treasuries to force down rates in attempt to increase lending and subsequently boost the economy.  Its actual impact on the economy can be argued, but from my point of view it has had a large impact on the stock market:

Shown another way:

So what is obvious from the charts is that the larger the Fed’s balance sheet, the higher the S&P 500*.  Further, when the balance sheet didn’t move we had almost a 20% move down in the stock market (red circle).

Anyway, the Fed is “tapering” their purchases.  What was once $80b a month is now around $25b.  They haven’t stopped buying and certainly aren’t selling, but they are cutting back.    So while day to day noise tend to be the headlines, the real focus should be on what happens when the Fed’s balance sheet stops getting bigger?

Please see the important disclosures that apply to this commentary HERE.  See important definition on the S&P 500 at the same link.  The above charts are for illustrative purposes only and does not attempt to predict actual results of any particular investment.  In regard to both charts, Source: S&P 500 - FRED and FED Treasury Holdings - FRED; calculations by CAL and idea via Market Anthropology

Avoid an Investment If…

Use research to come to an investment decision, avoid being a sheep

Maybe avoid is the wrong word.  More like don’t blindly follow.  I am talking about information friends, clients, family, etc. use as a justification why they (and you) should invest in ABC.  The following should give you pause, as they are fairly weak justifications:

1. Advice from a political pundits or their sponsors
2. Chain emails
3. A guy who got a past market call right
4. Anything said from a permabull or permabear
5. Golf course investing tips
6. Any inside information
7. A guy who has a TV show
8. Anything from an investment company
9. Returns that are much higher than the market
10. Anything you can’t really understand

And why:

1. They are pushing politics or their revenue stream, not investments
2. Usually crazy rumors with little basis in reality
3. Yes, could give the guy credibility OR every blind squirrel finds a nut
4. If they are always bullish or always bearish they have a predisposed view of the market
5. Typically people only talk about their winners
6. Aside from being illegal probably isn’t inside anyway
7. He or she is gunning for ratings, not necessarily investment advice
8. They are pushing a product (caveat: they could have some pretty good research)
9. All good things come to an end or it’s a total fabrication
10. More confusing = more costly AND/OR less idea of how it will perform

Of course, this list is not all encompassing.  Just what popped into my head.

Justified is the key word.  Any of the above may ultimately have the right call on the market or an investment; however, I would bet using any of the above as the ONLY reason to invest in something will often end in disappointment. 

Point being, do your own research to formulate your own thesis or find some research with an actual thesis before making a decision either way and if you see fit use one of the items from the list above to compliment that thesis. 

Please see the important disclosures that apply to this commentary HERE.