Content provided by Rusty Vanneman, CFA, CLS Chief Investment Officer
The stock market’s gains this year have been primarily driven by a combination of less investor fear, positive price momentum, and extremely favorable liquidity conditions thanks to central banks around the world, including here in the U.S.
In recent weeks, however, there is a growing concern that the Federal Reserve could begin considering when to exit their latest quantitative easing (QE) program. To do this, the Federal Reserve would have to begin tapering their bond purchases, which are currently at $85 billion a month. In turn, the stock market has exhibited increased volatility and an inability to keep pushing toward new highs, and yields have shot up in the bond market. In short, the market is having a taper tantrum.
While the topic of when the Fed will exit QE is important, it is also likely not an imminent event. For starters, Federal Reserve Chairman Ben Bernanke last week stressed that an early exit could hurt economic growth. Despite lots of chatter from various Federal Reserve chairmen, Bernanke’s voice is the one that matters most.
Besides, the Fed is a political machine. It will react after the data has clearly improved. And, at this point, unemployment remains elevated and inflation remains low. The former is definitely improving, but it will surely take a few more months of stronger employment growth (even stronger than we’ve seen in recent months). As for the latter, I fully expect to see inflation rise due to higher housing costs, but the gains aren’t likely to be enough to make the Fed move any time soon either. Wrapping it all up, it seems that it will be at least until the leaves start to fall again, at the earliest, that the Fed will begin to seriously consider tapering.
The market has had a great start this year, especially since economic and corporate earnings growth hasn’t necessarily been that strong. It would make sense for the market to take a breather and consolidate, or even retrace some of these gains. Call it a pause to refresh.