While unprecedented central bank stimulus is distorting markets around the world, there’s no easy solution in simply “following the Fed.”
The problem is threefold. First, there are theoretical relationships that describe how various asset classes are likely to perform in a liquidity-flooded market… but they’re just that, theoretical. In reality, the relationship doesn’t always perform as expected.
Another problem with jumping on Fed-driven bandwagons is that the market’s expectations are often already “baked in” to the price by the time the Fed makes a move. This leads many anticipatory investors to “buy the rumor and sell the fact.” As a result, late-comers lose money.
And finally, the Fed can say one thing and do another. That’s more or less what happened recently, when in September it said it would NOT taper, even though it had communicated its intention to do so just four months earlier.
Let’s take a look at a few asset classes and how they’ve held up after the “no taper” announcement. We’ll call this the “after-party.”
Stimulus is typically expected to prop up commodity prices, yet oil lost ground after last Wednesday. Of course, part of the bid up in price before the Fed’s decision was due to Syria, making it difficult to tease out the Fed’s impact, specifically.
Gold is generally viewed as the biggest winner during stimulus sprees. Although it hasn’t been this year, it is now up nearly 2% since the Fed elected to keep its bond buying program unchanged.
On the other side of the coin, excessive money printing usually spells trouble for the dollar and for bonds. Unlike the previous examples, the dollar held the theoretical relationship’s expectations, dropping after the no taper announcement. However, bond prices rose, and interest rates fell – the opposite reaction if you expect bond market participants to “punish” excessive stimulus.
In this case, the Fed had already talked rates higher heading into September, so its decision to maintain bond purchases at $85 billion a month was a bullish signal for bond prices.
And finally, while stock markets have grown “addicted” to the Fed’s stimulus, most equity indices pulled back since last Wednesday, a counterintuitive move.
Of course, it’s only been one week… so we’ll continue to monitor these trends over the coming weeks and months. Stay tuned.