Macro Wrap – TAPERING is the Green Pill

by Enis June 4, 2013 7:35 am • Commentary

With all the hullabaloo in the last month about TAPERING, the new big, bad, dirty word, a very important historical consideration has been lost in the debate.  Tapering is the positive, optimistic scenario.  It’s a sign of a stronger economy, better able to stand on its own two feet.  Most importantly, it’s better for markets too.

Before you call me all those friendly internet names, hear me out.  Over the past 20 years, what has been a better period to own risk assets – a tightening cycle or an easing cycle?  Always a tightening cycle.  Especially when we are already a few years into a bull run.  During the last 2 cycles, was it better to own stocks when the Fed was tightening (between June 1999 and May 2000, and between June 2004 and June 2006) or when it was easing (between Jan 2001 and June 2003, and between Sept 2007 and Dec 2008)?  Clearly when the Fed was tightening.

There are two main arguments against this outlook.  First, since monetary policy operates with a lag, some argue that it’s the tightening that sets the stage for the future economic weakness, and the easing that sets the stage for the future strength.  This is true, but especially applicable on the margin.  Given that we have been under ZIRP and QE for several years now, further QE does much less to change economic behaviors today than it did a few years ago.

The second, and louder, argument is that this cycle has been different.  The Fed has essentially been in an easing mode for much of the bull run.  But lost in that simplistic view is that the economy and profits were actually growing quite strongly between 2009 and 2011 (and 2012 was a flatter year on both fronts, but still positive).  The economy and profits seem to be on much shakier footing, and I would argue that both are more important for the trajectory of the stock market than the Fed’s actions.  If the Fed’s easing is no longer feeding through to a stronger profit environment for corporations, if that juice has been squeezed, then the easing or lack thereof is not the critical fulcrum for the market.  Growth, and profits and psychology are.

It’s the last point about psychology than might have the most credence.  But even then, the psychological impact of QE is a much more fragile foundation than the growth and profits pillars.  Just ask the Japanese.

Yesterday’s data helps to illustrate the importance of growth for stocks.  The ISM Manufacturing data came in lower than 50, in contraction mode.  Here’s the 20 year chart, with the red line at the 50 level:

20 year chart of ISM Manufacturing, Courtesy of Bloomberg
20 year chart of ISM Manufacturing, Courtesy of Bloomberg

Any stock market investor should prefer to see the ISM data above 50 rather than below 50.  Stocks usually perform much better when that’s the case.  Full stop.  Easing or no easing.  Plain and simple.

So while the initial reaction and commentary this week will be focused on whether good is bad and bad is good, or good is good and bad is bad, let me be clear on where I stand.  Historically, weak economic data has been bad for stocks.  And good economic data has been good for stocks.  Even over the past 4 years.  Even during QE-Infinity.  Tapering is the green pill.