The one exception was when Federal Reserve Board Chairman Ben Bernanke let slip in May during testimony before Congress that at some point before year-end the Fed would have to begin reducing its bond purchases. Equity and fixed income markets reacted violently to Bernanke’s remarks in May and again in June when he put a little more detail behind the concept of tapering (see “It’s the Fed, stupid,” below). This was an indication that market strength was more a creation of Fed policy than organic growth and the inevitable end to endless QE would end the bull run.
We now have seen five consecutive years of positive annual returns on the S&P. The last time we had seen that was 2003 to 2007, which was followed by a loss of 38% in 2008. Since 1970 there has only been one instance where the market had positive returns for more than five consecutive years and that was from 1982 to 1989 (see “Time for a fall?” below). By the time this article is published, we should have a better idea of how deep the correction that hit in January goes and whether there will be a deeper one, or even the start of a bear market.
Whether this turns into a bear market or not only time will tell, but there are signs it will. There are numerous variables this year, which include a change at the top of the Federal Reserve as well as a few of its board members. It is unknown whether or not Chairman Janet Yellen will continue with former Fed Chairman Ben Bernanke’s tapering plan of $10 billion per month or if she will make adjustments to this program.
Early signs indicate the Fed will continue to taper $10 billion per month and continuously wean the economy until there are no monthly bond purchases.
The Fed has made it clear that it is data driven and can change policy at any moment, but will they? At the very least the Fed showed that one bad data point would not change its commitment to tapering as it cut $10 billion from QE3 at its January meeting following a weaker-than-expected employment report for December. The next test will be the March meeting, as the January nonfarm payroll number was also significantly below expectations. The Fed’s decision to continue its program in the face of poor economic data is a sign of its dedication to continue tapering asset purchases. With the chaos in the emerging markets even some of the more dovish Fed members have come out and said, in so many words, that the emerging markets better get used to tapering because it will continue.