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Timing the Fed's Taper

BALTIMORE ( Stockpickr) -- First there was the fiscal cliff, then came the sequestration, and now the Fed's taper is threatening to usher in the next stock market apocalypse. Or is it?

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For the last five years, we've been junkies -- all of us. Markets have rallied on every hint of Federal Reserve stimulus, and they've sunk on the prospects of an end to Chairman Ben Bernanke's buying programs. In short, stock investors are addicted to the Fed's cash. And like any addicts, we're not reacting well to the idea of getting cut off.

The "taper," as it's come to be known, it the Fed's attempt at rehab.

By gradually slowing down its $85 billion in monthly asset purchases, the Fed is planning to wean the market off of the cash and get things functioning normally again. That's actually a bigger deal than it sounds. For the last five years, the Federal Reserve has pushed a very accommodative set of policies. By slowing them, Bernanke and company are saying that the recovery is finally robust enough to stand on its own two feet again.

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No matter whether you agree with that prognosis or not, if you're an investor, you can guarantee that the taper will effect assets that you own.

The real question is when.

Don't bother reading the Fed minutes -- they won't tell you. For the last five years, one single chart has been my go-to barometer for Fed QE efforts, and right now, it's suggesting that the Fed could very soon be shutting off the faucet. Take a look:

The chart above is the Fed's five-year forward inflation rate. It's a pretty narrow definition of inflation that the Fed uses internally as a QE gauge, and for the last five years, this chart has been able to predict big stimulus programs like clockwork: Every time the Fed's five-year forward inflation rate falls below 2.2%, Bernanke and company have pumped cash into the system.

Last year, the Fed got even more aggressive with QE programs, announcing QE3 and QE4 even though our chart was well above that critical 2.2% level. But the Fed has been a lot less aggressive lately, and a taper at least looks plausible up around 2.6% right now.
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