From the July/August 2013 issue of Futures Magazine • Subscribe!

Fed plants seeds for rational stock and bond markets

Many analysts believe the market overreacted to the news but also think it could be the beginning of a more rational market that reacts to the actual economic numbers, and not necessarily how those numbers will affect Fed policy. Typically, bonds and stocks are non-correlated and often negatively correlated, as bear equity moves often would create a “flight to quality” into bonds. But the Fed’s quantitative easing policies have changed that dynamic (see “Strange bedfellows,” below).  “The old conventional wisdom years ago was that when equities went up bonds went down and vice versa,” says Randy Frederick, managing director of trading and derivatives for Charles Schwab. “But that hasn’t always been the case; it certainly hasn’t been the case since the Fed began intervening back in ’08.”

Andrew Wilkinson, chief economic strategist for Miller Tabak & Co, notes that the Fed did a “very clever thing. The market was frightening itself ahead of every data point because it feared the Fed would taper. The Fed now has put the onus back on the data to prove that it should taper. So investors should no longer fear strengthening economic data.”

Matthew Buckley, CEO of Top Gun Options, calls this a bizarro market. “It is kind of like the movie ‘Blazing Saddles’ when the sheriff puts a gun to his own head; they said ‘he is crazy enough to do it.’ That is what the stock market is doing to Bernanke.” 

Others, however, believe the market reacted logically and see more pain ahead. “I don’t think the markets overreacted,” says Alan Bush, senior research analyst for ADM Investor Services. “It reacted as it should have because this is a change in policy and contrary to what [Kansas City Fed President Esther] George said, a tapering is a tightening, it is a change in their policy.”

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