It is August. More folks are on holiday. Volume is light. The stock market has quieted
down. However, more Fed governors are speaking up in favor of curtailing the growth
of the large QE program which has been the major driver of the market's strong advance
since late 2012. Normally when the Fed wishes to curb the growth of Fed Bank Credit,
it simply freezes it in inflation adjusted terms and uses tighter liquidity conditions to raise
short term interest rates.The stock market can shudder briefly but usually bounces back
so long as credit growth is brisk enough to fund continued economic progress.
Both the monetary base and M-1 monetary liquidity are very sensitive to changes in Fed
Bank Credit. In fact, I use real M-1 as a sort of ultimate longer term leading economic
indicator. Presently, the growth of real M-1 is running about 10% yr/yr . It has been
decelerating, but has been way too fast to create concern about the economy. A gradual
tapering in the growth of Fed Credit would push the issue whether real M-1 might be
slowing too fast well out into 2014. Even then, there might not be a problem for the
economy if credit growth is fast enough to fund both real output and cyclical inflation.
Moreover, if the Fed can trim its credit account without raising short rates, there would
even be less pressure for the economy. Finally, and if necessary, a new QE program
could be put in place to backstop a faltering economy.
Market players have loved the QE programs even as earnings improvement momentum
has slowed to a crawl. The QE programs, in underwriting a strong bull market, have
worked to allow confidence in the economy to recover from the depths. Straight line
reasoning implies that a reduction in and subsequent elimination of QE would damage
the stock market, undermine confidence and, in the end, punish the economy.
The history of this economic recovery suggests the Fed, if it goes through with its heavily
leaked new program could top the market for quite some time unless investors and
traders see enough in the progress of the economy to waive off QE as a concern. My
reading of the evidence since 2009 says that if this transition is to occur, it may not do so
quickly unless the economy surprises to the upside for a good several months as QE
I would dearly like to see the economy recover a faster stride and failing that, I would
prefer the Fed, if it concludes it must curtail the QE, go ahead in a very cautious manner.
QE curtailment, tapering etc. could well introduce a sizable element of perceived risk
into the market "equation" even though from a strictly monetary economics point of view,
no such worry should surface for another year or so.
Take a deep breath and think through carefully what I have outlined. I happen to like the
idea that the market could be close to where it is now a year further out in time before
the QE reduction issues are resolved and a new bull leg can begin. It is not a prediction,
just a thought. In the meantime, I will stick with my indicator disciplines.
SPX Daily Chart
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!