Summary: The cardinal rule of investing – and life, frankly – is “When the facts change, you have to change your point of view.” The Fed's decision to maintain its current pace of bond buying at the FOMC meeting is one of those fact-changing events. Markets were primed for a reduction, and along with a host of other flashing yellow lights that was enough to make plenty of market watchers cautious, including us. Yes, the Fed will eventually cut the QE tow rope if/when labor markets improve, but for now they seem content to keep toting the barge and lifting the bale. That leaves markets free to head to the bar, hopefully avoiding incarceration along the waty. Remember 1999, when markets ripped through Q4 because so many investors had bided their time waiting for the dot-com bubble to collapse earlier in the year? Cue the music, because this is beginning to look like the same market setup.
Forget financial assets – the most startling bull market since the 1990s has been demographic: the birth rate for twins has increased by over 50% since 1990. At the start of the 90s, according to US government statistics, there were about 23 twins born for every 1,000 live births. As of 2011, the last year for which data is currently available, that number had jumped to almost 34 per 1,000. Every ethnic background the government tracks for this data – white, African American and Hispanic – shows similar increase.
The reasons for this boom in double baby carriages are easy to understand, even if the outcomes are surprisingly successful. American women are waiting longer to start families and sometimes require fertility treatments, some types of which increase the likelihood of twin births. The technology behind these treatments has become more effective as well, adding to the overall trend. But from friends within this age cohort (I left it some time ago myself) comes this surprising anecdote: couples are specifically “Going for” twins with fertility treatments. Questions of medical ethics aside, this makes some sense. If you can safely start and complete your family of four with only one pregnancy, some portion of the population will take that path.
Moving over the distinctly less adorable but still timely world of central bank policy, the Federal Reserve today showed downside of actually tending to twins once you have them. Theirs aren't called Jacob and Sophia (2012's most popular baby names, by the way), but “Employment” and “price stability”. Central banks aren't generally in business of surprising capital markets, but the announcement that the Federal Open Market Committee would continue the current $85 billion pace of bond purchases has to count as the most unexpected policy decision since the Financial Crisis and round #1 of QE.
The other commonly referenced set of policy twins – Wall Street and Main Street – tells part of the story behind this decision. They are the Jason and Emma (second most popular names last year) of the story. Listening to Chairman Bernanke's press conference this afternoon, I was struck by his frank and honest portrayal of U.S. labor markets. Discouraged workers exiting the labor force. Unemployment rates which dramatically underrepresent the “True” social stress of unemployment trends got some air time. It was more like reading Zerohedge than listening to a typical central banker/economist two-handed conversation. Which is to say it felt refreshingly honest.
At the same time, Wall Street has done very well indeed under the QE umbrella. Stocks have more than doubled since the March 2009 lows, corporate profits are at record levels, and there have been some very large corporate transactions (think the Verizon bond deal) which feel more like a capital markets peak than a trough. The disparity between these outcomes and those in the prior paragraph are stark, and “Income inequality” is a trending topic again, if only in economic and political policy circles.
By keeping the QE bond buying program in place, the Fed is acknowledging that one of its twins (Wall Street) may be killing it, but the other (Main Street) isn't keeping pace. Given all the chatter about 'Tapering' (the word I would most like to strike from the dictionary) after the last Fed press conference, everyone who tuned into CNBC or picked up a newspaper in the last three months believed the Fed would reduce the program. What did the Fed see as it filtered through all its data at this last meeting? That the Main Street twin was actually falling further behind in school, even as the Wall Street sibling was being named valedictorian, president of the debate team, and captain of the soccer squad. Higher interest rate put the housing recovery in a lurch, and the jobs data continues to be weak.
So now investors have a pretty stark decision to make, because time is running out on 2013. We have been quite cautious on stocks over the past month, given not only the news from this Fed meeting but a host of other concerns. These included spotty ETF money flows (our proxy for investor engagement), valuations which did not incorporate declining earnings expectations, and worries over increasingly volatile interest rates. All valid concerns, and all now likely back-burnered for the 74 remaining trading days of the year.
This is beginning to feel like 1999, although you don't have to cue Prince if you don't want to. Just consider the following:
*In 1999, we had a Federal Reserve which pushed liquidity into the system ahead of Y2K concerns. Now, we have a Fed newly recommitted to liquidity operations to spark a better economic recovery.
*In 1999, many investors – including some the Street's best and brightest – openly mocked the ridiculous valuations afforded to tech stocks in the dot-com bubble. Now, we have many very smart people voicing similar opinions about U.S. equities generally.
*In Q4 1999, those smart hedgies ended up buying the market with both hands to play catch up for three quarters of underperformance. History doesn't repeat itself, of course, but it isn't hard to see the AABBA rhyme scheme of the bawdy limerick here. It may well be retail investors who finally capitulate and start buying, or hedge funds, or still cautious long-only managers. After all, who has really caught the whole move since March 2009?
Make no mistake – there is more than enough to be worried about as we get ready to hit the 2013 home stretch. Everything we listed as concerns, plus a host of other issues, wait in the wings. They will have their turn.
But in the meantime, we have a newly dovish (in the eyes of the market, anyway) Federal Reserve, a winning stock market year-to-date, and a raft of investors surprised by the central bank's move today. All that feels like a recipe for a melt-up. It may not rival a cute set of twins, but it won't take 9 months to deliver either.
Nicholas Colas is the chief market strategist at ConvergEx Group.
