Originally posted at Briefing.com
CNBC had to be feeling good about itself last week. Not only did it have the pleasure of highlighting some dubious business practices employed by its competitor Bloomberg, it also had the good fortune of conducting the interview heard around the capital markets world last Tuesday.
The featured guest was none other than successful hedge fund manager David Tepper of Appaloosa Management, who said in September 2010 that the stock market would do well either if the economy recovered on its own or if it faltered and the Fed intervened. What he effectively said then is that the stock market couldn't lose.
We know today that Mr. Tepper's view was right on the money. The real economy hasn't done great since 2010, yet the Fed has continued to intervene and the S&P 500 has rallied to a new all-time high.
Evidence Matters
What was learned in last week's interview with Mr. Tepper is that: (1) he is definitely still bullish on the market (2) he doesn't think the market should be overly concerned about the Fed tapering its asset purchases (3) he thinks we could see a period like late-1999 again if the Fed does not taper its asset purchases and (4) he is a fan of the 1992 movie My Cousin Vinny.
Regular readers know that I enjoy using pop culture references to make a point, so my ears perked up when Mr. Tepper brought My Cousin Vinny into the discussion.
In brief, Mr. Tepper said it was easy for him to be bullish because all of the evidence in front of him -- an improving economy, attractive valuation, and central bank support-- tells him to be. He likened the ease of establishing his viewpoint to the climactic scene in the courtroom at the end of My Cousin Vinny when all of the evidence, and expert testimony from Mona Lisa Vito, lined up to produce an obvious acquittal for Vinny's cousin.
The stock market appeared to buy what Mr. Tepper was selling. The S&P 500 increased 1.0% on Tuesday, aided by short sellers covering their positions in the face of Mr. Tepper's added opinion that they will need a shovel to dig out of their graves if the Fed lets the market party like its late-1999 again.
Big personalities like Mr. Tepper have an ability to move the market with their words, especially when the market knows they have been right with their prior calls. Predicting the future though is tough business. Sometimes the evidence is on your side and then it works against you when a bad decision is made, as the families of Nicole Simpson and Ron Goldman found out when prosecutors asked O.J. Simpson to try on a glove that didn't fit.
Mr. Tepper could be proven right yet again -- and who wouldn't want him to be other than short sellers? Still, based on the evidence below, we're hard-pressed to think the market is ready to handle the Fed tapering its asset purchases with a sense of aplomb.
Timing Matters
What is clear in the charts above is that global equity markets have surged on the back of supportive central bank policy. The parabolic move in the Nikkei in recent months, fueled by the Bank of Japan's embrace of a no-holds barred monetary policy, drives home that point. No major market, though, has gotten more out of central bank accommodation than the US market.
Since March 6, 2009, or just before the Fed announced a massive expansion of quantitative easing, the Russell 3000 has soared 150%. Rising corporate profitability has been integral to the advance, yet there has been no mistaking, particularly over the last six months, that the Fed's unremitting policy beneficence has been the key driver of stock prices.
The ingrained belief that the Fed is going to keep the easing pedal to the metal has enabled the stock market to drive to higher highs in spite of relatively weak messages from the real economy.
We understand Mr. Tepper's reasoning that the market shouldn't be overly concerned by the Fed tapering its asset purchases. The thinking being that the Fed will be tapering because the economy is improving. Such improvement would be a good thing for corporate profits.
The issue at hand in terms of how the market handles the Fed tapering its asset purchases really relates to timing. Will the Fed get its timing right when it ultimately decides to taper its asset purchases?
We said two weeks ago in Fed Policy as Easy as 1-2-3 that the Fed risks inviting a crisis of confidence if it pulls back on its asset purchases simply because it thinks the costs outweigh the benefits. To do so without the data providing sufficient evidence the Fed is meeting its dual mandate would be tantamount to admitting its policy approach has been a failure.
To be sure, if the market is going to handle a tapering decision well, it will need to be convinced that the Fed is meeting its own targets for satisfying its dual mandate. If it is not, a tapering decision could be quite unsettling for the stock market which has placed its full faith in the Fed providing unbridled monetary support in the face of weak data points pertaining to its dual mandate.
The evidence before us -- PCE inflation up just 1.0% year-over-year and the unemployment rate at a lofty 7.5% based in part on a depressed labor force participation rate -- suggests to us the timing is not yet right for the Fed to try and sell a tapering decision on the grounds that it has made sufficient progress in meeting its dual mandate.
What It All Means
The Fed has created quite the communication hurdle for itself. What it says about tapering its asset purchases is not as important as when it says it. The longer it holds its tongue, the greater the risk becomes that a stock market bubble takes shape. Conversely, the sooner it speaks, the greater the risk becomes that it saps investor confidence prematurely and triggers a reverse wealth effect.
Should the market be overly concerned about the Fed tapering its asset purchases? Yes, because the data has to validate that the timing is right -- and the data isn't there yet.
We appreciate that a lot of people don't like the Fed's policy approach. It is fraught with risk, yet the stock market's performance has made it clear that it is dependent on the Fed's unremitting support so long as it is clear that the Fed's dual mandate is not being met. For better and/or worse, the Fed's communication has made this so.
Mr. Tepper cleverly referenced My Cousin Vinny to defend his stock market view. For our part, we'll invoke another 1992 movie, A Few Good Men, which also had its share of courtroom drama.
The fact of the matter is that the stock market still needs the Fed on the wall, because the data haven't adequately prepared it yet to handle the truth of the Fed ordering a code red that tapers and eventually kills the asset purchase program.
Source: Briefing.com
