The long and short of things is we continue to feel another baby bear is awakening from hibernation in the equity markets as the aromas wafted from the Fed's institutional kitchen become fainter and less hearty with each passing month. What started out as comfort food and chunky soup is reducing itself down to just a plain tomato stock. By the time they start serving broth this coming fall, we don't think these paying patrons will be quite satisfied, considering what their palates have been accustomed to over the past five years.
In as much as we can appreciate the gesture, there really is no such thing as a free lunch - especially when it comes to markets and in light of the extraordinary assistance the Fed has extended over the past five years. Unprecedented? Perhaps as compared to the most recent tightening cycles in the last forty years, but certainly not without comparison when we look back a little further. As we have spoken to over the past month (see Here and Here), the closest market parallel we find is in the 1940's - the last time the Fed took up such an unconventional and extraordinary policy approach in the wake of the Great Depression and World War II.
While we would estimate risk is to the upside towards an abbreviated taper, we do feel that participants have put the cart before the horse when it comes to expectations with the actual tightening cycle. As shown below in the market profile from the 1940's, by the time the Fed had stopped buying Treasuries in support of the market, equities had corrected sharply and were sitting near the bottom of what became a three year consolidating range. Naturally, this adjustment by the market had profound effects on underlying market psychology which falsely feared a return to the Great Depression without the support of the Fed. Should we see a similar reaction by the equity markets through the balance of the year, we think expectations and posturing by the Fed will allude to lower rates - longer.
We saw yesterday that the sharp and seasoned eyes of Helene Meisler picked up both the seasonal and structured similarities with the secular Nasdaq top from 2000. While the performance divergence is wide between the two, the structure is remarkably similar and we believe would speak to a more cyclical variety. Curiously, we took another peak with the most recent Icarus trade in biotechs, and although it didn't quite match the unbridled artifact of that exceptional exuberance - it showed certainly more similarities than divergences.
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