The Independent Market Observer | Outlook. Opinion. Insight.

11/13/13 – Question and Answer

Written by Brad McMillan, CFA®, CFP® | Nov 13, 2013 4:21:32 PM

I have to apologize to Micah Crabdree, who posted a question on Halloween. Since then, I’ve either been preparing for our National Conference or attending it, and I meant to respond earlier. Sorry, Micah, but here you go . . .

The question concerned when the Fed was going to start the taper process—specifically, wouldn’t it be better to do so in a strong market environment, when the possible negative market effect would be limited, as opposed to a weaker environment, when the Fed’s action might serve to weaken it further?

Micah, I agree with you. The taper will more than likely result in a weaker market, and it would be far better to take that step when the market is strong. I was very surprised that the Fed didn’t start to taper in September, for exactly that reason, among others.

Most analysts are now predicting a strong market run-up to the end of the year, and I think that is quite possible. Given the strong GDP report and much-stronger-than-expected employment reports, which I discussed in previous posts, the Fed certainly has economic justification to start the taper before the end of the year—if it wants to. The possible effect of limiting an additional market run-up, given the present extended valuations, would provide more justification.

That said, I’m not sure that the Fed is looking to limit the stock market’s run-up. Much past policy has been aimed, explicitly or implicitly, at generating asset price increases. With the Fed’s self-admitted inability to see bubbles, I doubt that concern about the market being overpriced would drive the taper decision.

From an economic standpoint, I do think the taper should start in the very near future, but the decision framework the Fed uses has become increasingly difficult to discern over time. If I had to guess, though, I’d say the Fed is probably going to hold off for employment reasons until, perhaps, March of next year—and then maybe hold off because it would weaken the stock market. The upshot will be more stimulus. I hope I’m wrong, but that’s how it looks to me right now.

Thanks for writing, and keep the questions coming!