The world reacted very negatively on Thursday to the idea of a post-quantative easing economy. The oddest thing about the reaction to the Fed announcement was that not only did the stock market plummet but nearly all of the commodity markets fell just as aggressively despite the US Dollar strengthening. The big question now is whether or not the talk of tapering will effectively end the bull run of 2013, and where we go from here. With the market off the highs, sideways over the past few weeks, then sharply lower, it really is an interesting and difficult situation. The market showed us all how weak its legs really are.
There are the investors who have been long in the extended rally up and are not sure if this pull back is a time to lighten up or to take all profit off the table. Then there are the bears that have been building their positions but still with caution as they have been burned again and again since last November. Lastly is the crowd that decided to go to the sidelines months ago when they felt this rally was built on a house of cards yet wanted to stay well out of its way. When it comes to the stock market, everyone has an opinion, everyone has their indicators, and we are all correct eventually. Given this assumption I wanted to talk about some of the specific fundamental catalysts that may influence what lies ahead for the American indices.
Many have been calling for the beginning of the end of quantitative easing to be one of the few catalysts that will stop the stock market rally. It was at one point expected that the Fed would not back off before the unemployment rate hits 6.5% or the inflation rate comes up to 2.5%. When Fed Chairman Bernanke took the podium at the end of May, he stated that he would begin to unwind the easing if they could identify that the economy improved in a real and sustainable way. He had made similar comments in this most recent June announcement. Although economic indicators are positive over the past several months it is hard to show “real and sustainable” growth. I don’t know if you can call the sell off on Thursday, “panic selling” but it certainly is a skittish market and Thursday was aggressive. This market has shrugged off the “fiscal cliff”, slowdowns in China, the sequester, the Euro Zone crisis and potential world conflicts, which would point to stability and growth with a healthy recovery. This has not been overlooked by the Standard & Poor’s Credit rating agency as the US outlook was taken from negative to positive. Now, we must see if the market can be weaned from easing or if this will be the potential turning point. The objective is heightened growth and decreased easing.
Some of the downside concern is that if the stock market has in fact turned bearish and will potentially break through important support levels, the profit taking could be even faster and more aggressive. The leveraged growth funds that have made large profits in the first half of the year are going to preserve those gains at all costs. The impact of these scenarios is often exaggerated but then again it is impossible to say how far we can drop when we’ve come so far in such a relatively short period of time.
A bi-product of this bull and bear standoff that we have had since the last half of May is a choppy market, somewhat large swings, and some opportunistic short term trades. With the current headline risk in the market we could see these day to day trends continue through the summer as investors may adjust to a shorter term outlook. With the CBOE Market Volatility Index otherwise known as the VIX, crossing 20 for the first time this year, we could be making a more sustained shift to a higher volatility state. This would be a welcome change for the options traders, short term trend traders, and other breakout strategies that I work with.
It is certainly a market that causes you to look at a number of potential outcomes and find a way to conclude that you are appropriately positioned to manage risk as well as find profitable trades. While the Fed is currently the focus, the G8 summit, the actions or potential action taken by the Bank of Japan, and the European Central Bank’s next movements, are all important considerations.
If you would like to reach me by phone or email I would gladly discuss this market, the challenges and triumphs it may face, some other ways to asses risk on your portfolio, and CTAs that I feel could add benefit and diversification to your current allocations. As I will not have the pleasure to speak to each of you personally, I hope you all have a safe and fun filled summer and happy investing.