Are US equities psychologically adjusting to the taper?

By Ben Turney

We’ve just heard that US GDP in the last quarter grew by 1.7% against a projected figure of 1.1%. Even though the unexpected gain was negated by Q1’s downward revision of 0.7% to 1.1%, this number is still fairly decent. Of course when I say “decent” I don’t mean by historical standards, but rather in comparison to the lacklustre growth witnessed in most of the other OECD nations.

In spite of this reasonably positive news, the benchmark US indices have barely budged. It appears that the market is back to believing good news is bad. With the Federal Open Markets Committee due to release its policy statement in a few hours, the skittishness is understandable. Speculation is rife that the Fed is going to announce plans to start tapering its bond purchasing programme. There is now a two month hiatus in FOMC meetings and the next one is scheduled for September. A consensus has formed that the Committee will take the opportunity with this month’s policy statement to lay out plans to start scaling back its operations by the time of the next meeting. 

The tight intraday trading ranges of the last few weeks and the even tighter spreads between the opens and closes reflect the general nervousness.

The primary trend is still intact after the rally off the 100MA (grey line on the chart), but the market is looking toppy.

In some respects I am happy at the way this is all playing out. I’ve called it correctly and stuck to my view, even when much of the rest of the market got sucked in by the soothing words of various Fed representatives since June. Of course this meant I missed the recent rally, but I am trying to position myself to take advantage of a larger move than has recently occurred.

Rocket fuelled markets cannot last forever. When the fuel runs out the odds of a fall back to earth surely dramatically increase. We’ve seen this happen in recent years, first when QE1 came to an end and then in the aftermath of QE2. This time the tapering is likely to occur in a more controlled manner, but the withdrawal of this crucial pillar of support should have a destabilising effect.

Although I am not in the camp of doom-mongerers and do not believe the end of QE need be catastrophic, the psychology of the market can often be fragile. Once fear grips it becomes self-reinforcing and a mild sell-off can quickly develop into a rout.

However the problem I wrote about in Saturday’s piece has got worse. Although the chart above is the one I would have hoped for coming into this week, tapering expectations are now so widespread I can’t help but wonder if the market has come to terms with the possibility (at least in the near term). I have also seen an increasing number of articles all identifying different reasons why the market top is in place. I’ve agreed certainly with a lot of the coverage I have read, but sadly there has just been too much of it to feel entirely comfortable in this trade.

As of writing Friday’s short is ever so slightly underwater. Overall I think I have to back my original judgement and sell more into this market. The price is appealing and the risk/reward looks well balanced to use leverage, but my actions will be tempered by concerns.

Oh well, I’ve made my call so it’s now up to the Gods of fortune to see if I get rewarded!