The search for the last bear grumbling is on and WSJ.com located one of the contestants. Peter Boockvar, managing director and chief market analyst at the Lindsey Group, estimates that the S&P 500 may drop as much as 20% based on the assumption that the Federal Reserve will terminate its third iteration of quantitative easing (QE3) in 2014. He explains that, whenever previous versions of quantitative easing came closer to the end, the “Fed-fueled bubble” faltered, and that this time will not be any different.
While Mr. Boockvar feels that the Fed will actually get across the goal line by December, I believe that committee members at the Fed do not know yet know what they will do; that is, they will make decisions that are entirely dependent on incoming data.
Since most data tend to be uneven — and since Chairwoman Yellen is likely to err on the side of caution – I expect the Fed to skip a tapering increment or two at the least. At most? They may ratchet up the creation of electronic money printing to buy $100 million in U.S. debt each month. Indeed, we may see the central bank offering up more stimulus than when Ben Bernanke ran the show.
Sound crazy? Picture the acceleration of the decline in refinancing and mortgage applications if 10-year treasury yields drifted beyond 3.25%. Envision the hoarding of cash and the trepidation to hire full-time employees, as the combination of the employer mandate for small companies to provide health care collides with increased borrowing costs.
And imagine Chairwoman Yellen receiving conflicting data, from an ongoing decline in labor force participation to additional deflationary trends, the result of which would certainly threaten the Fed’s mandate of price stability.
Those who believe that the economy is increasingly self-sustaining argue that the rising rates will not choke off the recovery nor adversely impact stock assets. Others like myself and Mr. Boockvar see the U.S. economy as exceptionally dependent on easy-to-get, unusually cheap money. The difference in our outlook is that I believe the Fed will act to contain rates, using any combination of excuses that it sees fit; Yellen will be particularly motivated to avoid any perception that the committee has lost the confidence of the markets.
Keep in mind, of course, rates do not even need to rise for the Fed to decide upon more stimulus. A prolonged economic soft patch might create enough uncertainty that stocks decline quickly and a risk-off trade witnesses a flight to quality in bonds. In other words, even if yields are falling, Yellen’s Fed may feel the pressure to act if economic signs indicate structural weakness.
Since the economy is likely to demonstrate uneven, and, sometimes troubling data in 2014, expect the Fed to emphasize its “data dependency.” And if that emphasis does not bolster “risk-on” dip buying in a pinch, don’t be shocked if the committee votes to offer up additional stimulus measures.
One way or another, then, ETF enthusiasts should set aside a modest amount of cash for a highly probable corrective period. The cash should be used for exchange-traded vehicles on your “Wish List.”