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Stocks listen to the Fed, but obey the bond market

Michael Santoli
Michael Santoli

There’s really not much to worry about. When the big expected thing happens, whenever that is, it will be fully expected, and we should all be able to handle it without much trouble.

That’s been the message from a couple of richly credentialed central bankers in the past day or so, as they try to reassure investors that by the time the Federal Reserve starts snugging up interest rates, the move will be well telegraphed and will occur for the right reasons.

Fed Vice Chair Stanley Fischer gently chided investors for placing too much emphasis on the first rate boost, whenever it comes, because it will be merely the first tiny step on a long trip back to normal for monetary policy.

Ben Bernanke overnight sounded a similar note to audience in South Korea, saying that the first hike will be good news because it means the U.S. economy is doing better, and he added that he sees no real extremes in real estate or financial market behavior at the moment.

These gray eminences have the forces of logic and planning on their side. But it’s never possible to figure out exactly what set of calculations, expectations, hopes and delusions is priced into markets at any given moment. So this makes it hard to say with confidence that markets can absorb whatever policy shift occurs and trudge on undisturbed.

Tuesday’s downward wiggle in stocks suggests that investors still might have a bit of adjusting to do as they get prepared for a Fed looking to “normalize” in an economy not yet in obvious re-acceleration mode.

The major indexes’ drop of a bit more than 1% is best explained as a modest reaction to some better-than-expected housing and durable-goods data. This marginally firmed up the case for a Fed rate hike, lifting the U.S. dollar and short-term Treasury yields.

For sure, the move could also be seen as a bit of pent-up selling after last week’s unconvincing levitation act which wasn’t fully supported by broad momentum in the majority of stocks or participation by that now-villainized transportation index.

The broad market story remains the same, stocks caught in a historically tight range, withstanding profit headwinds fairly well with the help of ongoing financial engineering and generally healthy corporate sector.

The credit-market picture, far more than whatever the Fed might do in four months, continues to be the main factor in whether this narrow, tedious trading range in stocks resolves itself up or down.

A glance at the headlines this morning shows this reality clearly:

The Wall Street Journal crunches a pile of corporate data to show that big companies have doubled the proportion of profits directed to dividends and share buybacks in the past decade – helped by record issuance of ultra-cheap debt.

This week’s agreement by Charter Communications Inc. (CHTR) to buy Time Warner Cable Inc. (TWC) – an utterly expected move – is causing some anxiety among bondholders over the huge amount of debt that will be needed to finance the deal. As one bond fund manager commented: “This seems like a deal that Charter was set on regardless of the price, as long as the market would fund it for them.” That’s the kind of logic that prevails in high-liquidity bull markets, and it works to stockholders’ benefit until it stops.

And Apple (AAPL) is now preparing its first-ever bond offering denominated in Japanese yen, as it continues to shop the globe for the cheapest debt available while it pursues the largest return of cash to investors in history.

Calm credit markets, voracious demand for safe-enough paper and corporate managements motivated to redirect the cash to investors in their own companies and others - as long as this arrangement holds together, then the central bankers will probably be right that a spoon-fed rate hike is no big deal. So a big market call right now comes down to whether you believe it will hold together, or not.