Federal Reserve Chairman Ben Bernanke has had several mandates since the financial crisis began several years ago. One was to keep interest rates extraordinarily low for an extended period of time. Check. Another was to make the Fed more transparent. This one was humming along just fine....until Wednesday's Fed announcement. Bernanke shocked the financial world by delaying the tapering of asset purchases. Instead, the Fed Chairman left the current $85 billion monthly asset purchase plan intact. Investors reacted as if they had received another dose of QE. Check out the initial reaction at 2pm on Wednesday, September 18th, as the news was released:
The reaction was quite positive - initially. After all, it was more candy from the candy store. The problem this time, in my view, is that Wall Street had seen enough economic evidence to view the tapering of asset purchases as likely. In fact, just about every analyst on the planet expected a reduction in monthly asset purchases from $85 billion to $75 billion. In effect, the Fed had a freebie and they blew it. By week's end, the S&P 500 had lost nearly all of its Fed-induced rally.
I saw the initial reaction, but I'm not buying it either. Think about WHY the Fed left the purchases at $85 billion. They clearly don't like what they're seeing ahead in terms of economic growth. They almost certainly don't like what's been happening to home construction stocks during the interest rate rise since May. Check out the rise in the 10 year treasury yield since May and the impact it's had on home construction stocks:
Housing is a key component of our economy. The Fed has to pick its next battle. Beginning on the path of tapering would send interest rates rising further, almost definitely causing a further freefall in housing. The problem is that the Fed knows our economy is not strong enough right now to handle a further rise in rates and further decline in housing. And a rapidly declining home construction index would destroy confidence. So apparently their choice was an easy one. But this REALLY muddies the waters for equities and this is occurring just ahead of a likely showdown between Democrats and Republicans. Oh joy! (sarcasm)
Most of the reaction to the Fed's decision was expected. Interest-rate sensitive areas of the market did very well - again, at least initially. Utilities, REITs and home construction stocks soared. The dollar fell precipitously, spurring a rapid rise in gold prices.
The biggest surprise of all for me, though, was the negative reaction of one key industry group that benefited from all of the prior quantitative easing - banks. For a detailed chart on banks and my interpretation of what this could mean near-term in the stock market, CLICK HERE as this will be my Chart of the Day for Monday, September 23rd.
Happy trading!
Tom Bowley
Chief Market Strategist
Invested Central
