Wouldn't it be nice to know in advance how the economy will perform in 2014?
It would certainly be rewarding to know before everyone else how the stock market was going to perform. One could plan for the future — setting retirement goals and allocating funds toward major expenditures — not to mention get rich.
Unfortunately, we don't know what the future will bring. We still need to plan despite all uncertainty, and we probably won't get rich.
Our inability to know the future doesn't keep us from trying, though, especially where there is money involved. That explains why, when the stock market has had a rally, as it has in 2013, ideas that purport to “get you to the exits early” before a sell-off have a special poignancy.
Call these ideas, whether in the form of news, advice from acquaintances, etc., objections to the stock market's rally.
For the past several months and more, objections to the stock market's rally have focused on the winding down, or “tapering,” of the Federal Reserve's quantitative easing (QE) program. Here are the principal objections surrounding QE, and a few thoughts regarding each.
QE caused the rally, so tapering will end it. QE has been Fed policy in one form or another since the financial crisis of 2008-09. In the most recent version of QE, the Fed has been buying $85 billion per month of mortgage bonds and Treasuries from banks. In exchange for bonds sold to the Fed, banks have had funds credited to their accounts at the Fed.
With QE in place, the stock market has had double-digit gains each year beginning in 2009, with the exception of 2011, and the S&P 500 Index is up over 27 percent year to date for 2013. Two explanations are given for how QE has increased demand for stocks, making the stock market go higher.
First, the new bank deposits at the Fed created when the Fed buys bonds through QE and the money in the economy that would otherwise be buying Treasuries (but which the Fed is buying instead) amount to more money chasing other investments of all kinds, including stocks. Second, QE's massive bond buying has increased demand for bonds and, accordingly, kept yields on bonds and interest rates low. Low yields have made bonds an unattractive investment for many people, particularly for investors such as retirees who traditionally relied on their bond holdings for income. Some of those investors have been “forced” into buying riskier investments offering higher returns, including stocks, to make up for their lost income.
To the extent QE has increased money in the economy, it may have fueled higher corporate earnings, which would also cause stocks to go higher.
So it makes sense that reducing QE should cause interest rates to go up and stocks, possibly, to go down. But when the Fed announced this week that it would begin to taper its bond buying to $75 billion per month with the goal of eliminating its QE program by the end of 2014, the stock markets rallied. That may be because the Fed maintained its commitment to keep interest rates low and suggested it would act to keep short-term rates low in other ways if necessary.