Series Part 2 of 2
Continuing our discussion from last time, Tapering groupthink can cost you! , Part 1 of our 2 part series on tapering groupthink, poses the biggest downside market risk of the U.S. Fed Quantitative Easing (QE) program.
Groupthink can produce mindless selling triggered by emotional and knee jerk reactions to tapering talk. Made without any critical thinking, that behavior can produce stock and bond market turmoil.
Any selloff can work in your favor. Times of turmoil and volatility produce excellent buying opportunities.
During our last discussion we learned that for the time being, the Fed continues to press hard on the monetary gas pedal. Continuous purchases of $85 billion in mortgage backed securities each month pumps huge stimulus into the market. That high level of aggressive bond buying saved and now supports the U.S. housing market. That continually stimulates the economy.
Whenever there is speculative talk suggesting tapering is imminent, the market quickly shows a negative reaction. Taper talk related volatility will certainly upset some stomachs. We must keep in mind that the Fed has repeatedly said there are conditions that must be met before any tapering even begins.
Three indicators help us understand and anticipate the Fed tapering:
1. Employment numbers
First, employment numbers must improve, trend higher and remain at a higher level to convince the Fed the market is reaching full employment. The Fed will NOT begin tapering as soon as better employment levels are achieved. They must see the stubborn unemployment numbers move down and stay down before considering any tapering action.
2. Economic growth
Second, there must be broader signs of economic expansion and higher growth rates. Fed Chairman, Ben Bernanke remains convinced that the QE policy and programs are working. He will keep his foot firmly on the monetary gas pedal until economic results show greater growth. The Gross Domestic Product (GDP) is the report that must trend up further and stabilise at higher levels.
The soon to be new Fed Chair, Janet Yellen, will continue QE unabated. The change to a new Chair will not change the approach or policy. Tapering will be considered and begin only AFTER economic growth results are evident and not merely anticipated.
Third, the Fed must be convinced the deflation monster has been banished. The Fed will wait to see inflation trend above 2%. Further, inflation must also produce the desired positive effects of stimulating increased economic activity. Again, tapering will not happen in anticipation of change. Once the change happens and shows concrete signs of continuing, tapering will come into play.
Everything else is market noise. As always the market will produce great amounts of noise and diverse opinions. After all, if we all agreed, we would all be buyers or sellers at the same time depending on what we all thought. We need people on the other side so buyers and sellers can find one another to make the markets function.
To cut through the high level of noise, remember that markets are all about making money. Noise does not matter; earnings and growth of earnings do matter. When earnings are growing, the market goes up; when earnings fall, markets fall. Earnings are now growing.
You can also use a personal economic indicator. When you are spending more money and your friends and neighbors are as well, you have a good basic economic indicator. Such a small indicator is not at all perfect but is a practical basic indicator to consider when thinking about investing.
Waves of groupthink
For months now, the first mention or talk of tapering produces a quick herd reaction from market traders. As is typical in an uptrend, reactions can be expected as fast, hard and negative. No thinking or consideration of any consequences are involved.
Individuals in all groups including economists and analysts can fall into groupthink and stop critically thinking for themselves. That creates excellent opportunity for someone prepared to do their homework as well as doing their own thinking.
As has already happened for five months, each wave of groupthink selling in anticipation of Fed tapering, presents a buying opportunity. Each time the market has come back and then continues on to a new higher level. That uptrending will continue as long as earnings support price increases.
Also keep in mind that investors and traders share the market. In effect investors buy or sell and then sit down to plan their next longer term move. Their action leaves the market. On the other hand, traders are continually active, in effect on their feet seeking any short term or immediate advantage.
Traders trade and think short term. By their very nature, traders, the financial service companies and media all pay a great deal of attention to the short term market and any slight price fluctuation.
However, investors must learn to see the trend in the noise without letting the trading racket distract them. There are always emerging and growing winners to be found in the market. By playing the groupthink behavior to our advantage, investors can stay in and join traders by buying the dips.
In normal times the Fed does not purchase massive amounts of bonds to support housing. Typically or in normal times, private capital funds the mortgage market through bond purchases.
When the Fed actually begins to back away from the market by buying less or tapering their purchasing activity, some tricky financial maneuvering could happen. We can expect some bumps as markets adjust to the Fed tapering its bond buying behemoth role.
Many smaller private buyers will have to return to the market to bring in the needed demand. That will likely produce greater volatility during a period of transition which will take some time.
When the actual tapering happens, I expect the market will chill, however if economic growth continues, a thaw will quickly come. Once tapering becomes accepted as the new normal we will return to a rising market, as long as earnings can grow.
Already, in anticipation of tapering and the need to again attract many private investors into the bond market, bond rates of return rose in response to the first talk of tapering. The increased interest rates were immediately reflected in higher fixed rate mortgage costs. That has changed the fixed mortgage market prices over the last two quarters.
The Fed has emphasized the QE program would be slowly tapered. I anticipate the full transition will take five or more years.
Are you in as an investor or are you trading? Make a comment, ask a question, we can talk about it.
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