taper and looking at the strength of the economy that is perceived with this news,” said Chris Gaffney, senior market strategist at EverBank.
“The Fed did a great job telegraphing it to the markets, as stocks are moving in the opposite direction than you’d think,” he added of equities rallying on the news.
Errrr … sorry to spoil the party, but a couple of things here:
Firstly, the reason the market spiked is that the Fed’s Taper turned out to be a paltry $10 bn a month and notthe “whopping” $20 bn a month that had been floated by various Fed mouthpieces back in May cough-cough-cough-hilsenrath-cough.
Secondly, the Fed were at great pains to promise low rates for much, much longer — so the free-money party can continue.
(WSJ): The Fed went to great lengths to send the message that interest rates are staying low even longer than the Fed indicated earlier. It said today that it will keep interest rates low “well past” the time when the unemployment rate reaches 6.5%.
“The Committee now anticipates, based on its assessment of these factors, 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 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.”
Got that folks? Repeat after Ben:
“Tapering isn’t tightening.”
Thirdly, they managed to communicate that this policy will be reversible at the drop of a hat should things start to look as though the vaunted “recovery” is nothing more than a mirage conjured by their actions.
The danger in that reversibility is one for discussion another day. For now, the markets reacted just as you would expect, once they realized that they had faced down the Fed in the summer and forced them into a taper that is essentially a non-event.
“Only” $75 bn a month from now on? Of course the market went up after the announcement!
Source: WSJ
But amazingly, the mere fact that the Fed had committed to a tiny reduction in their rabid spending led to all sorts of people heralding the greatest monetary victory of the modern age.
Ambrose Evans-Pritchard, for whom I have a great deal of respect despite his somewhat Keynesian leanings, wrote a piece almost inconceivably entitled (and this deserves a line all of its own):
“Farewell QE, You Have Been a Magnificent Success”
Wait … WHAT?
Now, I’ve seen a few medals handed out halfway through races in my time … but THIS???
Ambrose, puh-leeze.
(Ambrose Evans-Pritchard): As the US Federal Reserve starts to drain dollar liquidity from the global system at long last, let us celebrate success. Quantitative easing has worked marvellously well. Monetary policy has been vindicated.
That’s just for starters. Once he hits his stride, Ambrose looks like a thoroughbred racehorse. QE Biscuit, if you will:
(Ambrose Evans-Pritchard): The US, UK and Japan are all recovering, moving closer to “escape velocity”. The Swiss National Bank — that bastion of orthodoxy — has kept its economy on an even keel by quietly amassing a bond portfolio equal to 85pc of GDP.
Call me old-fashioned, but “amassing a bond portfolio equal to 85pc of GDP” simply to keep your economy on an “even keel” doesn’t sound like success to me.
Before he’s done, Ambrose takes time out to laud Abenomics; and buried within the story of the stunning success of Abe’s policy, there lies, as the Bard would say, the rub:
(Ambrose Evans-Pritchard): Japan, too, has grasped the nettle, breaking free of its deflation trap with the most radical policy experiment of modern era, a repeat of Takahashi Korekiyo’s brilliant policies from 1931 until his assassination by military officers in 1936.
After two decades of monetary tinkering the Bank of Japan is mopping up 7.5 trillion yen worth of bonds each month, almost as much as the Fed in an economy barely more than a third the size. It is buying long-term debt for the first time. This ignites the broad M3 supply, now humming at a 3.4pc growth rate, the highest this century.
Japan was the fastest growing economy in the OECD bloc in the first half of this year. There was a hiccup in the third quarter, causing the faint-of-heart to write off Abenomics.
Yet Nomura’s Shuichi Obata says the December Tankan survey of business shows that confidence is at last spreading from big companies to small firms, with the services index rising above zero for the first time since 1991.
Much can still go wrong. Next year’s rise in consumption tax from 5pc to 8pc could abort recovery. The “Third Arrow” of Thatcherite reform planned by premier Shinzo Abe has yet to fly with much force. The Japanese bond market may take fright once inflation nears the 2pc target. Yet the Bank of Japan’s belated panache under Haruhiko Kuroda at least gives Japan a chance of averting slow collapse.
Yes, Japan has a chance of averting a slow collapse … and it may now be able to avoid that fate — in favour of a swift one.
Back in the 1930s, the rub came when Takahashi’s policies needed to be reversed once Japan, too, was on a somewhat “even keel.”
Whilst “Takahashinomics” (as the policies would no doubt have been dubbed had the Japanese press of the 1930s possessed any panache) did engineer a remarkable turnaround in Japan’s fortunes, it featured military spending that increased as a percentage of the total budget every year, from 31% in 1931, at the beginning of his tenure, to 47% in 1936.
When Takahashi set about unwinding his mammoth stimulus in 1936, however, things got a bit … sticky, as Myung Soo Cha notes in a paper entitled “Did Takahashi Korekiyo Rescue Japan from the Great Depression?”:
… when the worst seemed over, Takahashi began to be concerned about inflation and tried to revert to stabilization. Reducing expenditures, he attempted to put an end to debt financing, while at the same time urging the Bank of Japan to absorb money it had supplied in the course of debt monetization.
Ahhhh … the first Taper.
“What happened next?” I hear you ask. Well, I’ll tell you:
(Wikipedia): Despite considerable success, his fiscal policies involving reduction of military expenditures created many enemies within the military, and he was among those assassinated by rebelling military officers in the February 26 Incident of 1936.
The original Taper Tantrum, whilst extreme, demonstrates the problems that may be associated with taking away stimulus.
That is, the people who have benefitted from it may not like it.
They didn’t in 1936, and they won’t in 2014.
Before we move on, let’s see what Ambrose’s “Farewell To QE” looks like in graphical form.
This is a chart I’ve used many times, but the good folks at ZeroHedge have kindly updated it for me to reflect the reality of Taper Lite:
Source: Zerohedge
Farewell QE, indeed!
But, although 2013 was most definitely the year of QE, there were other interesting facets of “The Weak That Worked” that also bear scrutiny.
Take the strength in the US stock market, for example.
The S&P 500 made a seemingly relentless series of new highs as it powered through 2013. With a couple of light sessions still remaining, the total number of new highs for the year is an astonishing 44.
To put that into perspective, it means a new high was made by the S&P 500 Index — arguably the most important equity benchmark in the world — every 5.68 trading sessions during 2013.
On average that’s nearly a new all-time high once a week throughout the entire year!
Of course, that’s not how these things work, but the point is valid. The winning strategy for this year was to buy equities.
Not companies.
Equities.
Let me explain what I mean.
Source: Bloomberg
Behold the mighty S&P 500 Index as it makes its way from bottom left to top right with nothing but a few short-lived corrections impeding its stately progress.
Now behold the flows out of mutual funds and into ETFs:
Source: Gerard Minack (via Dave Collum)
At the risk of harping on, this is a phenomenon I’ve also spoken about before: the dumbing-down of investing.
In today’s markets, which function at the whim of the Federal Reserve as opposed to market forces, the art of researching companies, analyzing their balance sheets and the strengths and weaknesses of their business, and then trying to sort the wheat from the chaff has been lost.
Only a tiny minority buys companies anymore — everybody else just buys markets.
And it’s hard to blame them.
A look at the correlation of the S&P 500 to the Fed’s balance sheet tells you just about all you need to know. Since 2009, the correlation has been an astonishing 89.7%. Why would anybody not just buy markets, given that they are going to go up based purely on the Fed’s aggressive stimulus?
Sure, you could make more money by buying all the shares that might go up because they were good, well-managed companies with good businesses, and by shorting those that were going to go down because they weren’t, but contained within THAT strategy (which used to be called “investing”) is the risk that you could be (GASP!) wrong — so why bother?
Bizarrely, by creating an environment that forces those with capital to seek out additional risk due to the paltry returns afforded by zero percent rates, the Federal Reserve has steered investors to seek out the least-risky place to invest their money, and that has been equities.
Source: Greg Weldon
And 2013 saw the Fed take a BIG step up after what, in hindsight, was a rather anemic 2012 campaign.
Below is the percentage change in the Fed’s balance sheet during the calendar year 2012. The chart also shows the date QE4 was announced in December:
Source: Bloomberg
And THIS is the same chart for 2013:
Source: Bloomberg
See how this works now?
Nice and reliable. Consistent amounts of “liquidity” are pumped into the system every month, and things gently float ever higher. The only real hiccup for equities in all of 2013 was, in fact, the Taper Tantrum in May, when this stability was briefly threatened.
Doesn’t bode well, I’m afraid.
The chart below, deflating the S&P 500 by the ongoing QE experiment, which I included a few weeks ago courtesy of Raoul Pal & Remi Tetot of Global Macro Investor, strips away the effect of the Fed’s pumping and lays bare the market’s real performance. It’s one of the best charts I’ve seen this year, and it speaks volumes.
Source: Raoul Pal & Remi Tetot, GMI
Equity prices used to be a reflection of the strength of the underlying economy — after all, the component pieces of benchmark indices were functioning companies that existed in the real world where they need to manufacture something and sell it to a buyer in order to stay in business and make a profit.
So how have companies and the economy they constituted done in 2013? Well, the companies themselves have done incredibly well at tightening their own belts and squeezing every last drop of juice out of the lemons they’ve been handed. In fact, corporate profits have never been higher; and as a percentage of GDP they have scaled new and almost unimaginable heights, as the chart below demonstrates:
Source: St. Louis Fed
But under the surface and in the wider economy, the story is very different, indeed, as the mountain of cash on corporate balance sheets has led to an avalanche of buybacks, which has in turn boosted earnings and given the impression that things are roaring, when in fact the true story is a familiar one of an increase in debt. And it’s one that we saw not so very long ago:
(Karl Denninger): The second important thing to understand is that the other claim — “record corporate cash” — is true but intentionally misleading. What’s also at records is corporate debt, and what you must look at is not tangible assets (which includes cash, of course) but rather such assets less obligations, that is, debt. And when you do and compare against equity prices what do you see?
Let’s put not-so-fine a point on it — leverage, as expressed in the form of stock price to assets less liabilities, is at an all-time post-war high.
Yes, worse than 2000 and worse than 2007.
Assets less liabilities for corporations economy-wide are approximately where they were in the last quarter of 2004 or the first quarter of 2005. But stock prices are much higher in aggregate. That’s the correct measurement of operating leverage relative to the market — not how much cash they have or how many dollars of earnings they return today. It’s what the “corpus”, that is, what your ownership interest as a stockholder (that’s what you are when you buy stock) is that underlies your investment and thus how much you’re paying for a given unit of tangible assets less liabilities.
Source: The Market Ticker
This chart was bad at the end of 2012 — in bubble territory, for sure — which was a big
