No Tantrum for Investors
Contributed by Doug Walters, Max Berkovich
The Federal Reserve successfully navigated its first step in pulling back some of its asset purchase stimulus known as quantitative easing. Ever since the Fed started hinting at this move, the fear was a repeat of 2013’s “taper tantrum.” Tantrums are for infants, so either investors have grown up, or they are content for now to be soothed by a low Fed funds rates.
The Fed has two crucial tools in its arsenal for combating economic slowdowns: the Fed funds rate and quantitative easing. Many are familiar with the Fed funds rate. When you hear about the Fed raising or lowering interest rates, it is the Fed funds rate. When the Fed wants to stimulate economic activity, it will lower the Fed funds rate, encouraging low-interest-rate lending. Right now, the target rate is 0-0.25%, i.e., very low as the Fed combats the pandemic slowdown.
While the Fed funds rate is a way to control short-term interest rates, it is not always effective in impacting longer-term loans like the ones used for house purchases. Enter quantitative easing. Here the Fed uses its balance sheet to purchase longer-dated bonds to drive up demand and drive down yields. As part of its effort to combat the pandemic, the Fed upped its asset purchases to $120B per month. This week, the Fed announced it would reduce those purchases by $15B a month (“tapering” its purchases).
Any fear that investors would react negatively to the official taper announcement was quelled this week. The Fed’s announcement was met with falling bond yields and rising stock prices. Investors were well-prepared by the Fed for this move. But perhaps more important were the comments that the Fed would be patient in raising interest rates. This pacifier ensured no tantrums.
US Stocks put in another positive performance, continuing an exceptional start to the fourth quarter. Particularly impressive is the ability of stocks to continue rising despite the Fed beginning to taper its asset purchases.
Taper Talk
As expected, the Fed announced it would be tapering its monthly $120bn in asset purchases. The plan is to withdraw $15bn each month, which, at that pace, would result in the complete withdrawal of stimulus by mid-2022, though the rate will be adjusted as necessary. In addition, Chairman Powell said there are no plans for “liftoff” (i.e., beginning to raise the Fed funds rate). Some analysts fear that the Fed is behind the curve on raising rates, but the Chairman was adamant they are not and that the current bout of inflation is transient.
Getting Back to Work
The much anticipated monthly jobs number (non-farm payrolls) came out on Friday and beat expectations. 531K jobs were created in October, ahead of the 450K estimates. In addition, previous months were revised up. Unemployment fell from 4.8% to 4.6%. It is a good sign, particularly as the job market was still contending with some delta variant headwinds.
Earnings Power
Thus far, over 89% of companies in the S&P 500 have reported their Q3 earnings, and it remains a remarkable earnings season. Over 77% of companies beat expectations on sales with year-on-year growth of over 17%. Over 82% beat on earnings, with year-on-year growth of over 39%. Those are big numbers! We hear a lot from economic commentators about the coming “slowdown.” These comments need to be put into perspective. Growth of this very high pace is unsustainable, so a slowdown is inevitable. The question is, does growth slow down to a still high healthy pace or a low and unhealthy pace? Millions of investors ponder this question every day, and the recent performance of the stock market would suggest relatively few are betting on the latter.
A Vote?
As we type, the House is preparing to hold a vote on both infrastructure bills (traditional and social infrastructure). If the vote is held, and if the latter bill passes, it would still need to clear the Senate, which could take the rest of the month or more. Both of these bills have the potential to provide economic stimulus at a time when the Fed is beginning to pull back.
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