Although today's market decline was triggered by the FED's meeting minutes, they coincided perfectly with the IPM Model's prediction for an upcoming bottom in the next few weeks.
Meeting minutes showed that FED will start debating the end of QE (Quantitative Easing) in March. This is a big announcement, especially when every one was assuming that QE will continue forever. In other words, we are in QE Infinity. Based on this thesis many fund managers declared a long lasting Bull Market and went all in.
One such extreme measure of sentiment was seen in the Naaim Survey of Wealth Managers. It showed that 50% of fund managers were 100% invested into the stock market last. Their average exposure was at 90+%. This is one of the highest reading I have seen in this survey. Although a Bull Market needs bulls, it cannot continue its rise when all the buyers have already bought in. Because at that point, only sellers remain in the market. This can setup a dangerous decline for the market.
From a fundamental perspective, FED's minutes have wide ranging implications for both the Bond and the Stock Markets.
Bonds
Some analysts would argue that FED was the biggest buyers of bonds, and it was because of FED that the yields were so low. In fact, one of the goals of the QE policy was to bring down the yields so that investors and individuals can buy houses at an affordable interest rate. Therefore, if FED decides to end its QE policy, it would cause a decline in bond prices, which would cause interest rate spike. Spiking interest rates will be very detrimental for a fragile economic recovery, which is already being affected by year end payroll tax increase & the potential Sequestration cuts. In short, QE policy review will be bad for the Bond market.
Stocks
Other analysts would argue that Stocks were rising because of the QE money printing by the FED. This policy provided additional liquidity in the market, which caused commodities and stocks to rise due to the reflation theme. However, if FED takes away its stimulus, it might bring back the specter of deflation to the forefront. Deflation is the worst enemy of Stocks and commodities.
Commodity complex is already showing a very gloomy picture with Copper, Gold and other precious metals declining sharply over the last week. This suggests that Deflationary pressures have again taken hold, and could result in further stock market decline.
To summarize, FED's decision will impact both bonds and stocks. It is clear that since we are not in a robust economic recovery, any withdrawal of easy monetary policy will bring back the fear of Deflation. Deflation will result in Stock Market decline, along with a decline in the interest rates. Hence, even if QE ends, bonds might rise sharply. But this time the rise will be due to bad economic conditions, and not due to FED's Bond buying program.
Above is the fundamental argument in favor of the Bond market, in light of FED's meeting minutes. In the next update, we will discuss the technical and sentiment picture of the bond market which favors a start of new rally for the bond market.
Meeting minutes showed that FED will start debating the end of QE (Quantitative Easing) in March. This is a big announcement, especially when every one was assuming that QE will continue forever. In other words, we are in QE Infinity. Based on this thesis many fund managers declared a long lasting Bull Market and went all in.
One such extreme measure of sentiment was seen in the Naaim Survey of Wealth Managers. It showed that 50% of fund managers were 100% invested into the stock market last. Their average exposure was at 90+%. This is one of the highest reading I have seen in this survey. Although a Bull Market needs bulls, it cannot continue its rise when all the buyers have already bought in. Because at that point, only sellers remain in the market. This can setup a dangerous decline for the market.
From a fundamental perspective, FED's minutes have wide ranging implications for both the Bond and the Stock Markets.
Bonds
Some analysts would argue that FED was the biggest buyers of bonds, and it was because of FED that the yields were so low. In fact, one of the goals of the QE policy was to bring down the yields so that investors and individuals can buy houses at an affordable interest rate. Therefore, if FED decides to end its QE policy, it would cause a decline in bond prices, which would cause interest rate spike. Spiking interest rates will be very detrimental for a fragile economic recovery, which is already being affected by year end payroll tax increase & the potential Sequestration cuts. In short, QE policy review will be bad for the Bond market.
Stocks
Other analysts would argue that Stocks were rising because of the QE money printing by the FED. This policy provided additional liquidity in the market, which caused commodities and stocks to rise due to the reflation theme. However, if FED takes away its stimulus, it might bring back the specter of deflation to the forefront. Deflation is the worst enemy of Stocks and commodities.
Commodity complex is already showing a very gloomy picture with Copper, Gold and other precious metals declining sharply over the last week. This suggests that Deflationary pressures have again taken hold, and could result in further stock market decline.
To summarize, FED's decision will impact both bonds and stocks. It is clear that since we are not in a robust economic recovery, any withdrawal of easy monetary policy will bring back the fear of Deflation. Deflation will result in Stock Market decline, along with a decline in the interest rates. Hence, even if QE ends, bonds might rise sharply. But this time the rise will be due to bad economic conditions, and not due to FED's Bond buying program.
Above is the fundamental argument in favor of the Bond market, in light of FED's meeting minutes. In the next update, we will discuss the technical and sentiment picture of the bond market which favors a start of new rally for the bond market.
Thanks Naqvi and you have confirmed my belief that since QE1 started at the end of the Bush Administration, we created, and are in an asset bubble - plain and simple. And have been for a long time. With the Fed's notes yesterday, the only alternative I see to restablize the markets long term (years) is for the Fed to get out of the money printing business by ending QE Infinity so markets can "go it alone". This slowing of money printing should start to deflate the market just as the Fed inflated it - but the market will end up where it should have been four years ago without all the QE nonsense. I believe you're correct in that Bonds will start a rally as equity holders look to safety. Europe may not be the best place to be right now, especially if the Fed pulls the QE plug and the ripple effects of such action. Of course the argument against pulling the plug on QE Infinity is that the US economy is in a fragile state. But remember, we have been saying the economy has been in a fragile state for the last 4 years! Deflation is showing signs in commodities as Dr. Copper is grumbling and so are other commodities. Manage your risk and as always, be careful out there! Brad
ReplyDeleteI still don't get it. I've seen and heard that bonds are getting bubbly. So, if they explode, are interest rates going up down? and stocks go up?
ReplyDeleteAs mentioned in the IPM Model report to subscribers, we were waiting for buy signals. And as of today we have got 3 buy signals. Will discuss these signals in the next blog post. But we might be a closer to a buy than many are anticipating.
ReplyDeleteI bought some last night already. I had sold all my longs from 1350 to 1485 and 1500. I've been waiting for this drop. Now, i bought only 10% in pro etfs and relocated half of my 401k to small caps at 1498. If we go down more, i'll buy more. I think this is the bottom or maybe 1475 is the bottom.
ReplyDeleteBy the way, i'm looking in to buy some US dollars index : ) You all may think i'm crazy but i think is going up : )
DeleteI still don't get it. I've seen and heard that bonds are getting bubbly. So, if they explode, are interest rates going up down? and stocks go up?
ReplyDelete