Daily State of the Markets: To Taper or Not To Taper?

The question of the day on Wednesday was what to make of the market's sudden and violent reversal. In case you were out on the golf course, stocks rallied in the morning in response to Ben Bernanke telling the Joint Economic Committee that the Fed was still on the case and that any premature tightening of monetary policy posed "substantial risks." As such, the QE bulls continued to run and the indices stepped lively to new highs across the board.

Bernanke explained that if the outlook for jobs market were to improve “in a sustainable way,” the FOMC would then begin to gradually reduce the purchases of bonds (QE). The Fed Chairman added that such a plan to "taper" the bond purchases would not happen automatically and would instead depend on the incoming economic data. Mr. Bernanke further disclosed that the FOMC is currently discussing exit strategies and that he would provide more information regarding what many call the "QE-xit" over time. Finally, during the Q&A session, the chairman added that if economic improvement continues, they “could in the next few meetings take a step down” in the pace of purchases.

To anyone paying attention, Mr. Bernanke's statements brought little, if anything, new to the table. Everybody on the planet knows that the current plan is to "taper" the QE program when conditions show sufficient improvement. But if you've been watching the economic data, you know that the economy has stumbled a bit of late and because of this, the Fed wasn't likely to announce a change its tune in the near term. However, the general consensus among market players was that the Fed Chairman's testimony wound up being on the dovish side. And this meant that the QE party would likely last a while longer.

However, the Chairman's Q&A session and the minutes from last month's FOMC meeting provided the bear algos with some juicy headlines and a reason to suddenly worry that the Fed may be thinking about taking action sooner rather than later. The fact that the market had become extended during its recent one-way joyride to the upside also added fuel to the bear case as the dip buyers apparently decided it might be best to sit this one out.

The catalyst behind the Dow's intraday reversal of 270 points was clearly the concern that the Fed's "taper" could be right around the corner. While Bernanke appeared to talk out of both sides of his mouth on Capitol Hill (saying the economy was improving but not enough), the minutes from the latest Fed meeting were taken as downright hawkish.

The initial headlines from the release of the minutes focused on the fact that "many" members needed more data before deciding on the fate of the current QE program. However, it was the discussion of WHEN a plan to taper the bond purchase might begin that got the attention of the sellers.

The line from the minutes that seemed to be the problem read: "A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting (18-19 Jun) if the economic information received by that time showed evidence of sufficiently strong and sustained growth."

The key is the minutes indicated that the Fed was talking about starting to taper their QE program much sooner than most analysts had anticipated. Never mind the fact that the next line read, "However, views differed about what evidence would be necessary and the likelihood of that outcome." Never mind that the majority of the recent economic data (other than the jobs report) have come in on the punk side. Never mind the fact that its nearly the end of May and that there is little chance of the data perking up enough in the next three weeks to give the hawks the evidence they need to start "tapering" now. The bottom line is that the sell algos had all they needed to get the party started.

So, as is often the case after an extended jaunt higher, the market reversed hard on Wednesday. The bears could be heard talking about a "Key Reversal" day, which will purportedly lead to more downside action in the near term. However, since it's been more than a month since the bears have been able to produce even back-to-back down days and more than two months since stocks fell for three consecutive sessions, the jury is still out on whether or not the bears have gained possession of the ball.

The bottom line is the market was overbought coming into Wednesday and everybody knew it. So, with a long holiday weekend coming up, the question for today is if buyers are going to stick around and do their thing on Thursday/Friday or simply head to the Hamptons early and let the bears have their fun for a while.

Turning to this morning...

A violent reversal in Japan, combined with a weaker than expected Flash PMI in China is sending shockwaves through the markets in the early going as the bears appear to be in control at this stage. Despite better than expected data in Europe this morning, fears of a global slowdown as well as the ramifications of a 7% decline in Japanese stocks is pushing U.S. stock futures lower at this stage.

Follow Me on Twitter: @StateDave

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The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report and on our website is for informational purposes only. No part of the material presented in this report or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any Portfolio constitutes a solicitation to purchase or sell securities or any investment program. The opinions and forecasts expressed are those of the editors of StateoftheMarkets.com and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. One should always consult an investment professional before making any investment.

Posted to Investing 101 on May 23, 2013 — 9:05 AM
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