The financial markets are like chameleons sometimes: they can give the same response based on completely different conditions. Take this week, for example.
The Federal Reserve announced that in January they would begin to reduce their buying of government bonds by $10 billion per month. This is the beginning of the unwinding of what has been called quantitative easing. This Fed’s idea has been that by creating artificial demand for government bonds (by buying $85 billion of them each month), interest rates would remain low.
The extremely low interest rates have been cited by many observers as the primary driver behind this year’s 20%+ returns in the stock market. So, many of you may be puzzled that when the Fed announced that the economy was making sufficient progress to begin winding down its aggressive stimulus program, stock prices would shoot up by over 1%!
So to recap – the market goes up when interest rates go down, and the market goes up when the Fed announces that it is beginning to end its stimulus program. Believe it or not, this all makes sense, depending on your perspective. The Fed also announced that it was abandoning its 6.5% unemployment target as a signal for raising interest rates in the future. They further stated that rates would remain low for the foreseeable future, which is probably sometime into 2015. Finally, the market believes that any benefits that they are giving up with the reduction of quantitative easing will be replaced by stronger economic growth.
This is why trying to discern the future direction of the market is as difficult as picking the winning NFL teams from week to week. Even professionals have a very tough time trying to get these things right. Out of 68 economists at major firms who were surveyed on what action the Fed would take at this week’s meeting, just 9 got it right! That means 87% of these highly intelligent and highly-compensated economic scientists missed the boat. They make weather forecasters look good.