The Fed, the Froth, and the Future Of the Market

Watching the Fed's 'taper talk' will be a key

   

As a fresh wave of winter weather pummeled much of the country, the doldrums seeped into the financial markets as well last week. Investors were little nervous, with the S&P 500 pulling back from 1810 early in the week before wrapping up the week with a flat day Friday.

While Friday the 13th might be considered unlucky by some, that wasn’t the root of it.  The fact is that some investors are still afraid that the stock market is becoming too frothy and that it’s poised for a correction. And I’m amazed to see all of the negative articles churned out by the financial media that’s perpetuating this idea. Because I just don’t buy it.

Remember, corporate earnings among S&P 500 companies were essentially nonexistent for five straight quarters, but they finally materialized last quarter and are forecasted to improve each and every quarter through 2014. Because the stock market is now starting to refocus on corporate earnings, I don’t expect a big correction. I expect a rotational rally.

That is, the improving earnings environment is great news for stocks which are carefully picked for their fundamental strength. Meanwhile, this is probably bad news for many speculative stocks, those which have done well in 2013 but don’t have the earnings growth to sustain their prices. That’s where the froth is, not in the market overall.

The other reason that the stock market is nervous is a familiar one: Everyone is wondering whether the Fed will start to taper quantitative easing (QE) at next week’s meeting. “Taper talk” is in full swing.

On Monday, St. Louis Fed President James Bullard said, “A small taper might recognize labor market improvement while still providing the (Fed) the opportunity to carefully monitor inflation during the first half of 2014.” Translation: The Fed was impressed with the November payroll report and other employment related data and might try a tiny taper just to see how market reacts.

To be honest, yields on 10-year Treasury bonds are already up significantly in anticipation that the Fed will taper sooner than later, so it looks as if the market is already discounting the idea that the Fed will tap on the brakes. My current expectation is that the Fed will finally begin to taper no later than next March. By that time, erratic seasonal employment data in December and January will be behind them and a clearer picture of job growth should emerge.

We are seeing signs that QE has done its job. This week, the Fed reported that household net worth in the stock market improved by 2.6% to $77 trillion. Clearly, QE is causing a “wealth effect” that has already trickled down and helped create jobs and boost overall economic growth. Speaking of which, we also learned this week that retail sales grew 0.7% in November, which was in line with expectations but still solid growth. Consumer spending looks to be improving, due in part to rising household net worth.

And to top it all off, we actually got a budget deal in Washington to avoid another government shutdown in January. The House passed it last night, and the Senate is expected to follow suit next week. President Obama has said he supports the deal, which is supposed to reduce the budget deficit by $23 billion, but like most things emanating from Washington, DC, these savings are far in the future while increased spending and higher commercial airfare fees are immediate.

It’ll be a little strange without the brinksmanship running right up to the deadline, and the fact that there will not be another immediate government shutdown is one less thing for Wall Street to worry about.

 


Article printed from InvestorPlace Media, http://investorplace.com/2013/12/fed-sp-500-market-outlook/.

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