The stock market pulled back again this week, almost quite predictably following comments by the Federal Reserve reminding us it would wind down its money printing, bond buying, quantitative easing (QE) program.
The comments once again provided no firm guidance on the exact timing or scale of what is now being referred to in the financial press as the “taper,” only that it would occur at some point.
After spending some intense parent-child time during this summer break, I am perceiving an all too familiar pattern in the Fed’s behavior. I feel like the markets are being parented by the Fed.
Any parents out there will recognize the pattern. First the awareness stage, “junior, your behavior is irritating me and or others and it needs to stop.” Then the consequence state, “junior if you don’t stop irritating me and or others you will lose something you value (aka iPod, freedom, etc.)." And then the action stage, “OK, now it’s done, party’s over.”
Now I don’t think the market is annoying the Fed, but the communication techniques are very similar. After the June Fed meeting, Chairman Bernanke was clear the Fed was looking at when and how to scale back its QE program. The stock market reacted by dropping about 5 percent before resuming its bull run.
This week the Fed, through other Board members, once again commented the program could be scaled back sooner than later. Once again the stock market dropped, this time by about 2 percent, before resuming an upward bias.
At this point it’s fair to say investors know what is coming, and have an approximate time frame for when the QE program will end. With expectations set, when the Fed actually begins to taper the program perhaps investors will react to the news as old news and the transition away from the aggressive financial market support policy will be less volatile than anticipated.
From this investor’s point of view, I’m weary of the QE program. The financial system is largely healed from the 2008 credit crisis trauma, consumers are displaying more confidence as indicated by recent rises in orders for durable goods, autos and homes. Unemployment remains a concern, but employment growth always lags economic recovery.
Real economic prosperity and market performance cannot be driven by money printing and low interest rates. Real prosperity must come from innovation and profits. Right now profits are holding their own and innovation is exploding.
Smart phones continue to revolutionize consumer behavior, 3-D printing is disrupting how goods are engineered, medical breakthroughs such an immunotherapy are changing the way cancer is treated and the U.S. is in the midst of an absolute energy production revolution.
These are the trends markets should be focused on, and in order for this to happen we need to get the Fed out of the way. Government in the U.S. is shrinking on its own; this clears the way for private enterprise to begin creating prosperity. We need the Fed to get this memo as well.