Other people's business

RSS

Markets are going round Cape Horn

What will happen now that QE is starting to taper?

Ben Bernanke. Photograph: Getty Images

Having had good passage through the warm gulf stream waters of "quantitative easing" ("QE" to you and me) flowing strongly from the shores of the US and latterly Japan, markets have now reached what, in market confidence terms, may be regarded the investor’s equivalent to the nautical experience of going round Cape Horn. We are passing into the rough seas where the conflicting currents of one ocean system, meet those of another. That is to say - translated into impenetrable dry as dust market speak – where the expected "tapering by the US authorities of Quantitative Easing" meets US economies recovery, putting hitherto bullish equity market sentiment to the test. Will the equity bull market of recent times be wrecked by the withdrawal of cheap money? Can you have a continuing bull market fueled by near no cost credit when interest rates start to rise?

We knew that we had moved into these choppy seas this week when the yield on US 10 Year Treasury bonds went through the previous 2 per cent "resistance level" to close at 2.23 per cent. The ship’s timbers may have creaked a little but the SS Equity Markets sailed on the next day, blown by news of the gathering pace of US economic recovery in housing, employment and consumer confidence, only to be blown off course the following day by the shore winds of analysts’ concerns, as they publicly pondered what it meant? Suddenly, the thing that markets hate most - uncertainty - had arrived.

My own view is that equity markets needed what I call a "linear regression down swing" in prices to remain faithful to its longer term trend. In short markets look a bit overbought in a year  when investors decided it was unwise to "sell and go away in May" because they did not want to be out of the market, and short of stock, when something as big and important as the continued stirrings of the long awaited US economic recovery were being witnessed. Consequently, the market was flooded with bearish conjectures as investment banks’ scrambled to take profits on bull positions and at the same time, get back some stock for their market makers, who must have been "short" after a long bull run that continued un-seasonally into May.

I retain my early, long running bullishness of equities, because the US Federal Reserve will tread carefully in managing a return to normalizing its interest rate. I reasonably conclude that it will tailor sales of the bonds it acquired, to fit the balance sheets of non banking providers of finance and credit with enough leg room with the right kind of bond collateral at the right yields, to facilitate the working of short term cash markets. Generally, most big companies balance sheets are in good shape to withstand higher interest rates. As Franklin Roosevelt once reassuringly said, the only thing to fear is fear itself.

Next Article