From the March 2013 issue of Futures Magazine • Subscribe!

Equity bulls’ suspended sentence

Whose bull market is it anyway?

While it can be argued whether certain fundamentals are bullish or bearish in the long-term, one point is clear: Equities have been supported by the accommodative policy of the Federal Reserve and no one is sure what the markets will do once the training wheels are removed. Even the staunchest bull acknowledges the Fed’s quantitative easing is behind the current market strength. Will improved economic numbers cause the Fed to pull  away, and can the market rally on its own? 

Jeff Dean, principal with ITB Capital Management, is bullish in the short run but is not sure there will be clear sailing for the remainder of 2013. “Equities will advance for a short period of time,” he says. 

Dean doesn’t expect the Fed to rashly end QE, but improving numbers could cause it to reevalute it in the second half of the year.

“I am not sure the Fed will do anything for a while, [but] a lot of what we are seeing is due to the Fed,” Dean says. 

Lazzara agrees. “The one problem could be the Fed stepping back from QE once the economic numbers improve,” he says. 

The chances of that may have diminished after the poor, -0.1%, 2012 fourth quarter preliminary GDP numbers. The Jan. 30 Federal Open Markets Committee (FOMC) statement appears to err on the side of continued indefinite purchases: “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until such improvement is achieved in a context of price stability.”

The market’s reaction to the negative GDP numbers also is confusing. The Dow Jones Industrial Average and S&P  500 dropped minimally the day the negative GDP was announced, and both rallied to multi-year highs by Feb. 1, two days later. It appears the market is in a bad-is-good mode because bad economic news will keep Fed purchases rolling along.  

Europe: Out of sight, out…

While Dean expects markets to continue higher in the first half of the year based on improving numbers, perhaps even taking out the 2007 highs, he does see a correction in 2013. “I am not 100% sure things are resolved. Europe has not been holding the market down, but is still a risk. They haven’t solved any problems over there,” he says. 

Lazzara also predicts a stronger first half in 2013 and sees the end of QE as a potential hiccup for the market in the second half. “It will be a stair-step up, rising to the 1550 area without much of a pullback,” he says. He expects the S&P 500 to rally 10%-15% in 2013 but settle about 8% higher if the Fed retreats in the latter part of the year. 

Reynolds expects a minor correction of 5% to 10% at some point in 2013, but sees equity indexes gaining as much as 30%. 

The two wildcards mentioned by all are government gridlock on the debt limit or some other governmental dysfunction, and the Fed ending QE. Few analysts expect another debt ceiling fight and most expect the Fed to err on the side of continued QE rather than a premature exit. 

Although equity markets appear strong, it seems we are not out of the woods yet. Returning to more normal market drivers — built on real growth  rather than Fed stimulation — may include some pain, so traders should be cautious and prepare for one more act in the financial crisis drama. 

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