How Quickly Things Change

"My other piece of advice, Copperfield,' said Mr. Micawber, 'you know. Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. The blossom is blighted, the leaf is withered, the god of day goes down upon the dreary scene, and - and in short you are forever floored.  As I am!" - An excerpt from Charles Dickens' David Copperfield

It seems like an eternity ago that the bulls were pushing the markets to record highs.  Three days later and everyone is wondering if this is the beginning of the end.  All of this over the most recent federal reserve comments that they would begin to reel in their massive quantitative easing program.  Note that they did not say that they would stop and also note that they did not say that they would slow down today, all they said was that it would be appropriate to moderate the pace of asset purchases later this year if incoming data supported the Fed's projections for continued improvement in the economy.   Bernanke also said, that it was possible the program could come to an end by the middle of 2014 if substantial improvement in the labor market (viewed as a 7.0% unemployment rate, surprising how quickly this number has moved higher) has been achieved.  Should the data show poor economic prospects then the Fed will continue to print.

So let's see, if the economy is weak then they will continue to support and market's can go back to new highs.  If the data is good, then they will remove their support and the market tanks!  I could not make that up if I tried.  If that makes no sense to you then at least you are thinking rationally. 

Taking a look at the market reaction it is clear that it needs the support to operate.  Yields on the 10-year note spiked to just below 2.5% taking the builders down with its rise.  The housing market is still tentative and this small rate increase was enough to spook the market and demolish building stocks.  Think about that, rates move to 2.5% and this move took building stocks down 12% in three days! If you want another analogy I received some research the other day that showed that in 2006 when the Japanese central bank tapered their quantitative easing program and rates in Japan moved from 1.5% to 2.5% their market fell over 20%.  If rates here reach anywhere near to 3.00% I would imagine that the same thing would be felt here.

It will be very interesting to see what the Federal Reserve does now as it is clear that their support is what is keeping the market buoyant.  Already a statement has come from has come from the St. Louis Fed President James Bullard saying that the committee's authorization allowing the Chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed.  The question is when is the appropriate time?  As the markets are so tethered to the Fed any reduction in their support will result in a nosedive no matter when it is announced.  If they truly think that they can time it so that the market is perfectly priced based on economic outlook and that they can slip out of the back door without the market noticing then they are smoking something really strong that is certainly considered illegal in California.

As I have mentioned before and I will mention it again, the market is being manipulated by the Federal Reserve, they have a history of thinking that their policies are helping when all they are doing is creating a larger problem, increasing debt levels has never resulted in economic prosperity and they will never have the ability to exit the market without there being carnage.  You have seen some of it this week and while I am not ready to call the recent highs a top, it certainly smells like one.  Best stick with the advice of Mr. Micawber.