Buckle your seatbelts and batten down the hatches. A growing cadre of Wall Street analysts is predicting that the Federal Reserve will finally taper its ongoing $85 billion-a-month QE3 bond purchase stimulus at its policy meeting on Wednesday.
In notes to clients this week, economists and strategists at Deutsche Bank and Capital Economics highlighted the fact that the major worries keeping the Fed on hold back in September and October have disappeared.
Monthly payroll growth has reaccelerated as the unemployment rate has dropped to 7% — a level Fed chairman Ben Bernanke fingered back in June as the rate that would prevail when QE3 ended. Congress is working in a bi-partisan fashion, removing the threat of another disruptive government shutdown in January. New homes sales have been strong. And the bond market seems to have settled into the idea that the slowing of the Fed’s long-term bond purchases doesn’t mean that short-term interest rates are going to be raised anything soon.
So if the much dreaded and delayed taper is finally going to happen, how should investor play it? Here are three ideas.
Click to EnlargeThe precious metals have been a disaster zone since inflation peaked in 2011 and the tin hat conspiracy theorists shifted their attention to the Bitcoin craziness. But with price of physical gold dipping below the all-in cash cost of new production, forcing high-cost production to be shuttered, good old supply-and-demand fundamentals look ready to be put back in play.
While a taper would, on its face, be a negative for gold and silver (tapering should be a positive for the dollar and result in lower future inflation expectations on a slowdown in the pace of monetary policy stimulus), the Fed has made clear that it’s looking to pivot away from QE3 bond purchases in favor of “forward guidance” — essentially the promise to hold short-term rates lower for longer.
This could take the form of a reduction in the unemployment rate threshold the Fed wants to see before raising its short-term policy rate. That reduction could be interpreted in a pro-inflation way, which would benefit gold and silver.
Short Emerging Markets
Click to EnlargeBack when the potential for a taper was first broached back in May, stocks shuttered at the thought the Fed could back away. But the response was much more severe in the bond and currency markets. Emerging market economies in particular have been dependant on the Fed’s cheap money flow, since it kept the dollar weak vs. currencies like the Indian rupee and encouraged capital flows out of the United States and into emerging market equities.
So as taper talk intensified, this dynamic reversed and sent emerging market currencies and equity prices reeling.
This dynamic is in play again. Just look at the examples: The rupee is sliding lower again, the Market Vectors Indonesia (IDX) is retesting its August taper fear lows, and more broadly, the iShares Emerging Markets (EEM), which surged in September on the surprise “no taper” decision before peaking in October, has been lagging behind U.S. equities ever since. Now, the EEM is struggling to stay above its 200-day moving average.
Click to EnlargeA derivative of the previous idea — if you’re looking for a more targeted sector-level play on the taper, consider areas with heavy emerging market exposure. Chinese solar stocks fit the bill and have been rolling over nicely over the last few weeks as shown in the chart of the Guggenheim Solar ETF (TAN) above.
Disclosure: Anthony has recommended AGQ and EEV to his clients, as well as TSL short.