Fed Says Taper Is Coming. But Bulls Hear 'No Taper Now'

 | Aug 29, 2021 02:20AM ET

h3 Market Rallies As Bullish Trend Remains

As discussed last week, the bullish bias remains as “dip buyers” jumped into the markets. As discussed in our Daily Market Commentary Friday morning:

“While the market continues its bullish advance (why not with $120b in QE), the divergences between price and other internal indicators continue to diverge. Another trip to the 50-dma would be a near 3% crash, and a decline in the 200-dma (which hasn’t happened for one of the longest spans in 40-years) would be a 10% disaster. (While I am sarcastic, the low volatility market experienced this year will make even normal corrections seem much worse than they are.)

For now, the ‘stair-step’ process continues with bounces off the 50-dma to slightly new highs before the next decline. At some point, investors will slip and fall down the stairs.”

The lack of a definite timeline on tapering from the Fed on Friday gave the “bulls” the boost of confidence they needed. As long as monetary policy and accommodative policy remain intact, there is a greater fear of “missing out” than of “losing money.”

Nonetheless, the rally on Friday set the 52nd new high for this year and the market is well on pace to set an all-time record of new highs this year.

Of course, none of that is important as long as the “bullish bias” remains intact.

The only mistake investors make is believing the current trend will extend indefinitely. It can’t.

h2 First Half Of The Full-Market Cycle/h2

When you look at the long-term market cycles, there are oscillations between secular (long-term) bull and bear markets over time. Using long-term trendlines, we can make the case the first half of the current secular bull market began in 1980 following the crash of 1974. If we plot out the first half of the cycle, it currently intersects at 4500 on the S&P index (although 5000 is well within the margin of error.)

Whether or not you agree with cycle theory is mainly irrelevant. What is important is to note several things in the chart above.

  1. Previously weekly 2-standard deviation extensions above the 200-week moving average resulted in signficant corrections.
  2. The current 3-standard deviation above the 200-week moving average is a historical anomaly.
  3. A correction back to the long-term bullish trendline would require a 68% decline.
  4. A 50% correction would take you back to the March 2020 lows.
  5. A 38.2% correction wipes out all the gains back to January 2018.
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That information is not meant to be “bearish” or to scare you into selling into cash. However, not acknowledging that such a correction WILL eventually occur leaves you at risk of impairing a large chunk of your investment capital.

Without acknowledging risk, you are essentially driving a car blindfolded. It will work for a while. But, eventually, it won’t.

However, as noted above, as long as the Fed is engaged in QE, investors believe there is “no risk.“

But is that about to change?

h2 Taper Is Coming, Bulls Hear “No Taper Now./h2

On Thursday, Esther George, Robert Kaplan, and Jim Bullard suggested the Fed start tapering its balance sheet expansion and prepare for hiking rates. To wit:

“It would continue to be my view that when we get to the September meeting, we would be well served to announce a plan for adjusting purchases and begin to execute that plan in October or shortly thereafter.” – Robert Kaplan, CNBC

“We did say that we would allow inflation to run above target for some time, but not this much above target. So for that reason, I think we want to get going on tapering and get it finished by the end of the first quarter next year.” – Jim Bullard, CNBC

“When you look at the job gains we saw last month, the month before, you look at the level of inflation right now, I think it would suggest that the level of accommodation we’re providing right now is probably not needed in this scenario. So I would be ready to talk about taper sooner rather than later.” – Esther George, CNBC

While investors fretted the Jackson Hole symposium would result in a firm timetable for an aggressive tightening campaign beginning as early as September, such was not the case. As Powell’s comments show, the message delivered was a perfect combination of ambiguity, vagueness, and misdirection on timing and amounts of an eventual taper.

After Powell’s speech, Fed Governor Harker continued with vagueness around the taper, stating:

“The Fed has reached an agreement that tapering will begin this year.”

All the market heard was “No taper now,” which immediately translated into a panic bid to buy stocks.

h2 Powell Emulates Greenspan/h2

During the runup to the Dot.com crash, then-Fed Chairman Alan Greenspan became famous for “Greenspeak.” Such was his unique gift of saying much while saying nothing.

Chairman Powell’s on Friday:

“The bottom line, and the reason for the market’s dovish eruption: Powell provided no explicit taper signal, as he likely wants to see more jobs reports for accumulated evidence that ‘substantial further progress’ on the labor market is being made, while dismissing soaring inflation as transitory.”

As we noted for our RIAPro Subscribers , also on Friday:

“In particular, the following line is assuring investors the Fed will not be aggressive with tapering QE. In regards to premature tightening Powell said: ‘Today, with substantial slack remaining in the labor market and the pandemic continuing, such a mistake could be particularly harmful.‘”

Below are two critical segments from his speech:

  • We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the “substantial further progress” test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.
  • The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test.
h2 Keeping The Faith/h2

Don’t be mistaken; the Fed is going to start tapering this year. So while the bullish bias remains currently, with liquidity continuing, that will change. As shown last week, asset prices do not do well when balance sheet reductions begin.

For now, however, there is still plenty of monetary accommodation combined with “faith in the Fed.”

That “faith” and near-record levels of stock buybacks keep a continuous bid beneath stock prices. But, as we noted in our daily market commentary on Thursday:

“In the years before the COVID-19 pandemic, one of the biggest sources of buying power in the stock market were the companies themselves. As the economy has improved, the stock market has rallied, and corporate buyers returned as a force in the stock market. Via BofA:

‘Buybacks by corporate clients accelerated from the prior week to the highest level since mid-March, driven by Financials. Financials has now overtaken Tech as the sector with the largest dollar amount buybacks so far this year.’” – Yahoo