The great unemployment rate and better than expected jobs numbers are yesterday’s news. In this market of short-yardage gains, as it faces defensive obstacles weekly, it is amazing how strong the offense is. Now we focus our attention on the December Federal Reserve meeting. It is the last of the year and the Taper talk is ramping up. Steve Linesman (Keynesian economic reporter for CNBC) stated that he NOW believes they WILL taper in December (by $10 billion). We also have the US budget talks, which the spin doctors are telling us is a done deal, but we are learning it just might not happen. As the market obstacles continue to be tossed our way, the market continues to charge harder and higher. Can it continue?
The hopes of a Santa Claus rally quickly faded at the beginning of December as the market started to sell off. Yet, the government’s monthly labor report for November brought new hope and renewed optimism. Unemployment is at 7% and over 200,000 jobs were created (despite all the obstacles in Washington, including a shutdown). The headlines are good and even when we peer under the hood, it’s not that bad.
So what market obstacles are coming our way that could derail a Santa Claus rally?
Taper in December?
It seems that the taper issue has recently been ignored, but is now gathering steam. The Federal Reserve meets December 17-18th and it includes a press conference. With the recent better than expected unemployment rate and monthly average job creation of 195,000, coupled with inflation below 2% (based on the CPI), if we are to believe that the Fed makes policy decision based on their dual mandate, then yes, we could see a taper. Another factor to take into consideration is the contraction of the budget deficit. Between higher taxes (payroll) and the sequester, the Federal Government’s deficit has declined. With the Federal Reserve pumping in $85 billion a month, their bond purchasing as a percentage of the deficit is increasing and could soon be at 100%. There is certainly room to taper, even a small amount.
Steve Liesman (CNBC) has come to the conclusion that they will taper and the taper will bring the monthly bond buying down to $75 billion a month (a cut in QE of $10 billion). There is probably some room to do that. I am not sure what the exact number is, but I suspect they may have some room to taper.
Progressives say NO!
However, Paul Krugman (NYT) and some other Progressive political pundits, including some members of the Federal Reserve, think we need MORE stimulus and the sequester is hurting this country. This camp would rather see an increase in money printing and stimulus, rather than a taper. While a few Fed members have spoken, both for and against taper, the two people we have NOT heard from are Janet Yellen (the presumed next Fed Chairman) and Bernanke (current Fed Chairman). From Yellen’s recent testimony and speeches, she has framed her argument that we can’t taper and must be vigilant in creating jobs and more stimulative efforts. Meanwhile, it is Ben’s last meeting and it could come down to his legacy and feeling the need to start to put down the trillion dollar monster he created by offering the first cut.
Mathematically, government data points show there is room, if you believe the government data. Bernanke started the whole “taper talk” last summer and I personally believe he would like to herald the ending to the QE program he started. Yet, there remains an army of Keynesian Fed Governors, a President who wants more stimulus and is at odds recently with Bernanke, and of course, Yellen, who seems to be more in favor of increasing rather than cutting.
There is another monkey wrench to toss into the whole December meeting and any possible taper decision. While it is becoming a news story in its own right, I wonder how many people understand the possible connection between the Fed Taper question and what else is going on.
In the Beltway, two people are sitting down and hammering out a budget that should carry the nation forward for two years. Republican Fiscal Conservative Paul Ryan and Democrat Patty Murray from the Senate are working together to finalize a deal that is expected to be released before the FOMC meeting. In fact, they could release it as early as today. The media and spin doctors are acting as if it is a sure thing and there is a lot of optimism around it happening. I believe the hype around the possible deal is that no one believes the Democrats and Republicans are willing to face another government shutdown and bloody battle that drags their poll numbers into the mud.
However, this morning we quickly learned that what the spin doctors and media have been hyping in a vacuum. No one has really asked the people that will VOTE on any proposed budget. The problem is no one really knows what is in the deal, other than the two people working on it. Yesterday some Republican leaders in the House stated that from what they heard they would oppose the budget. This morning Democrat leader Steny Hoyer of the Senate said he opposed it, but admittedly said he didn’t know what was in it. What no one is talking about are the two deal points that are highly contested. The President gave Patty Murray her marching orders that he needed to raise taxes and reduce the sequester. We know from Paul Ryan’s budget (ironically the ONLY budget that has ever been fully drafted beyond some talking points in the last few years), maintains sequester level cuts but reallocates them and has been very limited on any possible tax increase. Can they put a deal together? The media and pundits think so, but the bigger question is would enough Democrats and Republicans vote for it?
The Government Needs Money!
While the budget story is garnering steam and we should hear something as soon as today, it also plays into the Federal Reserve’s possible taper. Remember, it’s a math question beyond the government’s inflation and employment data points. Right now the Fed has to print money and buy bonds, regardless of their dual mandate, because they are the only one that is willing to lend the government money at very low interest rates. If a deal is not brokered and we face another budget battle in January, I don’t think the Federal Reserve would be comfortable tapering in the blind, not knowing what could happen to the deficit come January.
Remember, the Fed alluded to their reluctance to taper in September by stating their concern about the government shutdown and budget battle. Could we be facing a similar circumstance?
Lastly, what will a taper mean for the market? When the taper talk first started in the summer the market sold off. The market confused QE and interest rates. It assumed that taper also meant raising interest rates, which would create equity market pressure. Has the Federal Reserve done a good job of framing their possible Taper to mean that it will only be a small amount and it will (should) not impact the interest rates? Has the market priced it in?
Some market professionals are starting to decouple any taper from their market expectations. More and more the battle in the beltway is in a vacuum as companies continue to think of themselves as players in the global market place and not just handcuffed to the ebbs and flows of the domestic economy. Could companies and the market ignore the taper?
I am on the fence. The President and Yellen don’t want to taper. Bernanke is on the fence and I think he would like to start it before he leaves. The government data shows general economic improvement that gives them room to do so. The government’s deficit has slightly decreased to give them some room.
The obstacles continue to be lobbed in, but the markets have navigated these waters and the government circus is becoming slowly more of a sideshow as the rest of the world seems to be focusing on the real math.
Support & Resistance
It seems that 16,000 will be the battle line in which we wait for the Taper and Budget Deal/Battle to bring forth optimism or pessimism. Expect a knee jerk of volatility – up or down, in the coming week.
Much like the Dow Jones and the S&P 500, this index has seen a decent recovery and their remains some strong tech stories for the holiday season. The 3500 level is the battle line.
The VIX is holding up in the high 13′s and low 14′s. It is pricing in some expected short-term volatility and is probably fairly priced at this point. It looks like we might see a 2-5% move in December (up or down). The battle line is 1800.
The broader index is not back up to that battle line of 1145. It sold off yesterday in the early session while the rest of the market was positive. It seems that the broader market trend is to move to the sidelines and let the over-weights and higher volatile issues rule the day. General market order flow is weakening and has remained weak in December, show more trepidation than anything else.
Will the Market ignore Washington?
The market had done an amazing job to avoid the barrage of challenges we face. The nation is becoming ever more polarized and divided, to the likes of which I have never seen. Certainly there is a wealth effect, which is not just about the wealthy, but anyone with modest savings and low debt is seeing their equity rise. However, the nation is still straddled with majority of the population that are struggling with huge amounts of debt relative to income (if they have a job) and little to no access to credit. We have seen Walmart and Target warn and lower their sales forecast. Black Friday saw its first contraction in initial sales (down 2.6%) in years, and consumer debt continues to mount.
The market and the economy continue to be fueled by zero interest rate policies and leveraged debt, for those that have access to it (mainly businesses and those with assets).
For all the criticism that Greenspan received for creating the housing bubble, based on running low interest rates (at 1%), Bernanke has only received praised for doing the same thing. But isn’t the Fed just creating another bubble, as Greenspan did just a decade before?
Right now it is about the mood of the market and how the market will react to a possible Taper. Any possible budget deal will certainly play a part in the Fed’s decision and it is that decision which will ultimately either continue to fuel the credit expansion and leverage debt, or create a pause and note of caution that we could be getting ahead of ourselves.