10/29/14   QE3 Concludes

Editor’s Corner

Ron Rowland

The Federal Open Market Committee took the final tapering step today and ended its third round of quantitative easing, which has ballooned the Fed’s balance sheet to $4.5 trillion.  Principal payments will still be reinvested and maturing Treasuries will continue to be rolled-over at auction, so the balance sheet won’t see any substantial or significant adjustments anytime soon.

The Fed noted it sees moderate expansion in economic activity and finds positive progress in the labor market with solid job gains, a lower unemployment rate, and improvement in the underutilization of resources.  Even though the policy change was fully expected, the immediate market reaction to the official announcement was to push interest rates higher and tug equities further to the downside.

For those seeking to find a hint of change in the interest rate policy, well, they went without.  The FOMC released similar wording to previous meetings, “The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.”

Market watchers had been speculating the Fed would pay special attention to the recent drop in the inflation rate, which remains well below the 2% target.  Instead, the committee glossed over any implications and blamed slumping energy prices, “Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.”

With the Fed discontinuing its buying spree, it would seem there would be lack of demand in the bond market.  Not so, as much of the slack is being picked up by U.S. commercial banks due to a regulation finalized earlier this year.  The rule, called the “liquidity coverage ratio”, demands that banks be able to tap into a reserve of high quality, liquid assets sufficient enough to run their operations for 30 days at a time the economy finds itself in a tight corner again.  The banks need to meet 80% of that goal by the beginning of 2015 and be fully compliant by 2017.  That is a creative way to ensure other buyers with deep pockets cover for the Fed’s absence.

Investor Heat Map: 10/29/14


The Utilities sector has a reputation for holding up better during a market decline and then lagging severely on the subsequent rebound.  It lived up to its reputation during the recent market downdraft, but it broke from tradition during the rally.  Instead of lagging, Utilities continues to keep pace with the broader market and maintains its top ranking.  Health Care has been one of the best performing sectors since the market turnaround commenced two weeks ago, and it climbed from fourth to second this week.  Real Estate and Consumer Staples were both pushed down a notch by the rise of Health Care.  Five more sectors moved from red to green this week as Financials, Industrials, Technology, Consumer Discretionary, and Telecom posted positive momentum.  Industrials was the most-improved of the bunch, performing slightly better than Technology.  Materials and Energy are the only two sectors remaining in the red, and their performance over the past week suggests they may stay there.  Analysts are debating whether falling oil and commodity prices are a sign of economic weakness or if they will be catalysts for further economic expansion.


All eleven of the style categories moved from red to green this week on the back of a strong market rebound.  They hit bottom two weeks ago with momentum readings ranging from -13 to -40.  The spread narrowed and scores improved to a range of -7 to -14 last week.  The spread between top and bottom remains tight as the rising tide is lifting all boats.  Large Cap Growth has been trying to provide the upside leadership and is able to keep that role today.  Mega Cap and Large Cap Blend held their second and third place positions.  Mid Cap Blend and Mid Cap Growth both climbed a spot while Small Cap Growth jumped three spots higher.  The trio are now locked in a three-way tie for fourth place.  Value appears to be losing ground to Growth as Mid Cap Value and Large Cap Value both slipped in the rankings.  Small Cap Value remains just one place off the bottom, where Micro Cap still resides.


The U.S. resumed a positive trend and kept its place at the top of the rankings.  Meanwhile, all the other global categories trail behind and continue to post negative momentum readings.  China, Pacific ex-Japan, and World Equity maintained their relative rankings, although Pacific ex-Japan narrowed the gap between it and China and is now vying to take over the second place spot.  Japan, Canada, and EAFE all improved one position.  Canada’s recent ascent in the rankings could stall if the Energy sector remains weak.  Emerging Markets fell three spots and is now at the bottom of a tightly bunched trio that includes Canada and EAFE.  The U.K. and Europe occupy the ninth and tenth spots and remain in steep downtrends.  Latin America has now completed its round trip, which took it from tenth to first and then down to last in the short span of four weeks.  Its moves have been volatile, and since they were not correlated with the market’s moves of the past month, the relative ranking changes were abnormally large and swift.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“If we did get any extension to taper, it would spook everybody. Everybody would think there’s a skeleton in the closet that’s about to pop out. It would be much worse than helpful.”

Michael Cloherty, head of U.S. rate strategy at RBC Capital Markets, 10/29/14


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