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Investors crave a new story line as the Fed waits

Michael Santoli
Michael Santoli

Everyone said it was a close call, and that any move would make little real difference. So why all the confusion and overheated talk after the Fed declined to raise rates yesterday?

Maybe because it leaves the market stuck.

Even before the S&P 500 (^GSPC) reversed a quick rally attempt on the Fed’s dovish statement focused on global risks and low inflation, the index sat exactly halfway between the record high of a few months ago and the panic low in late August.

Investors also remain stuck without a fresh story line about the economy and interest rates. Disappointing growth and market tantrums have repeatedly interrupted the narrative of an improving economy that calls for higher, more so-called “normal” Fed policy in the past few years.

Yet the fact that investors (and journalists) are tired of this story and impatient for a new one shouldn’t be reason enough for Janet Yellen to bump rates higher, and yesterday it wasn’t.

The absence of a stronger signal that the Fed is intent on starting liftoff by year’s end confounded forecasts for a so-called “hawkish pass.”

But everyone is splitting hairs here: No one who has been paying attention should have been too surprised with the decision, no matter which way it went.

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Now, of course, the extrapolation machines are humming, and Wall Street forecasters who didn’t see this coming are pushing out an initial rate move into next year.

This might turn out to be the way it goes, of course, but it’s worth looking back a couple of years to a similar instance when such assumptions turned out wrong.

Two years ago almost to the day, the Fed opted not to start tapering the pace of its QE bond purchase program, confounding many expectations. Then Fed chief Bernanke cited recent “tightening of financial conditions” and stubbornly soft inflation. Those concerns echo today.

Quickly the Street pushed out its predictions for the taper into the next year, believing the Fed was loath to make a big policy shift in December due to concerns about market liquidity. The very same concerns are flaring now.

Yet in December 2013, Bernanke did indeed initiate the taper, a process that ended with the sunsetting of QE last October.

Interestingly, in 2013 – with the market already up big into September – stocks initially rallied on the “no taper” announcement, then pulled back about four percent over the next four weeks, then kicked off a strong fourth-quarter rally.

Yet the market added to those gains into year-end, after the tapering announcement in mid-December, as investors finally got a new story line of “policy normalization” to tell. Nothing says Yellen won’t follow the same path.

Yet it’s worth noting that the total progress from there for stock investors has been modest. From 2013’s closing level of 1848, the S&P 500 is up only 142 points through Thursday’s close.

That’s a 4.5% annualized gain at a time when the domestic economy has strengthened considerably, the housing market is humming and unemployment is threatening to break below 5%.

This might be the big takeaway from the interplay of the Fed, the economy and markets: Most of the benefit to financial assets of easy money policies has been felt. The real economy has been catching up to the markets, at a time when global concerns are dragging more on asset values than on U.S. growth.

Main Street outperforming Wall Street is not a bad storyline. But investors are still trying to adjust to it.


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