Taper Ghost Stories

Source: Mark Wilson/Getty Images News.

On the eve of All Hallow’s Eve (better known as Halloween), the tale of the taper remains a ghost story. Like witches, goblins, ghosts and ghouls, it’s oft-feared but never materializes (though we’d suggest it’s more like the Great Pumpkin). In a fairly unsurprising twist, the Federal Open Markets Committee (FOMC) announced Wednesday it won’t start tapering quantitative easing (QE) bond purchases this month. To many, this was welcome news—and totally unsurprising. Manypeople still believe the economy will crater without Fed funny money, and to them, it went without saying that QE would continue. To us, that’s a sign investors still have both feet firmly planted in skepticism—a good indication this bull market is far from over.

As usual, the FOMC’s rationale was buried in Fedspeak: “Taking into account the extent of the federal fiscal retrenchment over the past year, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.” In other words, like Linus in the pumpkin patch, the Fed is waiting, waiting, waiting to see more economic improvement. They didn’t fall asleep and miss it—they acknowledge the economy is growing and unemployment is falling—but they suspect the darned sequester is still weighing on things, and it’s their job to offset it. (Though, we’d note QE’s bond purchases are likely an equal, if not greater, weight on growth.) Yep, like many, the Fed clings to the notion slower growth in government spending is a whopping negative—even though actual government cuts haven’t prevented the economy, job market and stock market from growing over the majority of this expansion.

This is exactly what the Fed said in September’s “no taper” press release. Then, markets shot up after the announcement—the taper delay was a big happy surprise to those folks who, in our view inaccurately, believed the economy can’t survive without QE. Then, consistently improving economic data led many to presume the Fed would start pulling the punchbowl. Unemployment hasn’t reached the Fed’s 7% taper target, but most data showed the economy was gaining ground, so easing off, um, easing seemed logical to some.

Then came the government shutdown and debt ceiling debate. And with the shutdown came data delays—many were sure the Fed couldn’t taper without official numbers to guide its decision. Others just believe the shutdown whacked growth and take it as a given the economy needs more Fed support. Expectations quickly shifted and as October’s FOMC meeting neared, folks near universally expected QE to continue.

Overall, it’s clearinvestors are still skeptical the economy can stand on its own. For investors, this is good news. Skepticalinvestors are worried investors—worries lower expectations. Worries are good! Stocks move on the gap between reality and expectations—big worries mean a big gap and a potentially big positive surprise when reality ends up even just ok. That’s bullish. As more of the many positives at work become noticed—like, say, if QE ends and they see an economy that’s still growing or (dare we say) accelerating—they gain confidence and become willing to pay more for a share of companies’ future profits.

When exactly this happens, no one can say. It certainly won’t happen overnight. Grinding skepticism is still abundant, and it takes time for emotions to morph—sentiment typically moves gradually. And there likely won’t be any one catalyst. A more positive media might help investors notice economic data are overall improving—no small feat, considering how well bad news sells. Maybe a few months of good news also helps investors start moving on from long-familiar worries. Or maybepeople just see more business activity in their own community. Maybe all of the above, to varying degrees.

In the meantime, speculation continues about when the taper will finally start. We’d suggest not wasting too much brainpower on that endeavor, though—Fed members are a funny flock. This Fed hasn’t yet followed logic, and it’s tough to imagine them starting now. They say they’re waiting for better data, but who knows—maybe they’re really waiting for banks to meet their higher regulatory capital ratios. Only time will tell, but for now uncertainly continues to fuel overarching skepticism—meaning this bull has room to run.