Wednesday, 30 July 2014

Fed Tapers Further, But The Fed Put Endures

Right, as we all know by now, free market fundamentals are overshadowed by Fed policy and actions in the U.S. world of investing. The Greenspan/Bernanke/Yellen, no longer merely implied, but very explicit put, is what really counts for overall asset prices in the broad scheme of things. 

When the, on many counts, useless but widely followed measure of economic growth called GDP for Q2 2014 today reportedly jumps 3.95% on an annualised basis in so-called "real" terms from Q1 to Q2 (4.06% in nominal terms on a YoY basis), the stock market drops even as the GDP numbers allegedly beat expectations (DJIA is down 0.19% at time of writing). Why? Because it gives the Fed, at least for now, a reason to continue tapering. And that is what just happened. Effective this August, the Fed will reduce its monthly asset purchases by a further $10 billion a month, to $25 billion. Since December last year, the Fed has now reduced, or tapered, monthly asset purchases by a total of $60 billion, or 70.6%. 

This means, ceteris paribus, there will be less freshly minted fiat dollars entering the market and hence reduced liquidity especially when it comes to pushing yields on longer-term treasuries and agency mortgage-backed securities down. What effect this will have on those yields and the stock market remains to be seen, but commercial banks have certainly taken on a much bigger role once again in driving money supply growth

This is really exciting times to be an observer of financial markets. And maybe, just maybe, real investment and valuations skills based on analysing fundamentals excluding artificial stimuli will once again be the only game in town. Ahh, I was just dreaming there for a beautiful second or two, so please don't bet on that happening any time soon - the Fed is ready, it has told us so on numerous occasions, to turn on a dime, or as they put it in today's statement:
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. However, asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.

And the Fed has been ready to turn on a dime for the last 100 years and probably will be for the next century as well. Perhaps more so than ever before as unsustainable and massive government debts, not to mention malinvestments, are lurking all across the world. So continue paying attention to what the Fed says, but pay even more attention to what it actually does. Still, never be tempted to ignore fundamentals (e.g. earnings, asset quality, profitability ratios, credit quality etc), of which the money supply is an integral one. And it will be as long as the U.S. has a fractional reserve banking system backed by its central bank (read: the taxpayer and owners of the US dollar). The same applies to other countries.

Reserve Ratios of U.S. Depository Institutions - Better, But Still Very Fractional

Lessons Worth Remembering: Who Predicted the Bubble? Who Predicted the Crash?