Last week, we went on record saying, “We are anticipating the Fed will announce another $10 billion monthly reduction from $75 billion to $65 billion” at its upcoming FOMC meeting. Yesterday, the Wall Street Journal joined in with a front-page column stating, “The Federal Reserve is on track to trim its bond-buying program for the second time in six weeks…a reduction in the program to $65 billion a month from the current $75 billion could be announced at the end of the Jan. 28-29 meeting.”
One reason for the continued tapering cited by the Wall Street Journal is that although the December employment report was lackluster, it did not diminish the Fed’s expectations for solid U.S. economic growth this year. Last week we discussed the labor force reductions and their impact on why the economy might not be as strong as the 7.0% to 6.7% drop in the headline unemployment rate would otherwise suggest. Apparently, Fed members were aware of these concerns and seemed to doubt the economy was truly as weak as the report implied. They suggested that weather and statistical anomalies may have skewed the December report and pointed to strong consumer spending and a pickup in trade.
Last year’s pace of $85 billion per month in purchases added $1.02 trillion to the Fed’s balance sheet. Today, that balance sheet has a whopping $4.07 trillion in assets. Tapering should eventually reach the point where growth of the Fed’s balance sheet is halted. However, no one appears to be discussing what happens next. Reducing purchases is one thing, but actually reducing the size of the Fed’s balance sheet is another. The balance sheet will likely swell to nearly $4.4 trillion before the bond buying program ends. The Fed could embark on an asset-selling program at that time to unwind its prior quantitative easing stimulus, or it could just let the $4.4 trillion remain on the books.
Today, there is a near-linear drop-off in momentum as we move down the sector rankings. Health Care kept its place at the top, while Technology moved up a spot to grab second place. Technology recovered strongly last Tuesday following the Monday setback and extended its gains into Wednesday. Technology then spent the next three days digesting its healthy two-day advance. Industrials slipped to third while maintaining strong momentum. Materials and Financials are in the same positions as last week, rounding out the top five. Telecom and Consumer Discretionary swapped places with Consumer Discretionary moving down on retailing concerns. Real Estate was on the bottom for many months until it climbed ahead of Utilities a week ago. Today, it climbed another two places and brought Utilities along for the ride. That means we now have new occupants in the basement. Energy slid down a notch, and Consumer Staples dropped three places to land at the bottom.
Micro Cap extended its lead over the other categories once again. Momentum often has persistence, and a momentum-based strategy can be very profitable when it does. As noted last week, Small Cap Growth has also broken away from the pack, although it has not been able to keep up with the torrid pace of Micro Cap. This week, Small Cap Blend is also trying to separate itself from the lower ranked categories to join the leaders. Fourth-place Large Cap Growth through ninth-place Small Cap Value defines the pack this week. There is not much consistency across the middle ground, which contains the nearly opposite extremes of Large Cap Growth and Small Cap Value. Large Cap Value and Mega Cap are somewhat separated from the pack to the downside, although the distance is not significant at this time. Micro Cap at the top and Mega Cap on the bottom implies the market is favoring an aggressive stance.
Like the sector rankings, the global categories have a near-linear falloff in momentum today. Unlike the sectors, which managed to all remain in the green, the falloff across the global categories extends deeply into the red. All eleven regions are in the same relative order as a week ago, led by Europe and the U.K. Strength still lies with the developed markets, as all eight categories fitting that description are above the three developing market designations. The value of the U.S. dollar versus other currencies can have a dramatic affect on the relative performance of foreign stocks when converted back to dollars for U.S.-based investors. The volatile currency swings of 2008-2011 have abated the past two years, leaving foreign stock performance to speak for itself.
“We’re likely to continue on a path of gradual, measured reductions in the pace of purchases, assuming the economy tracks as we expect it to.”
John Williams, San Francisco Fed President, January 2014
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