Predictions of the future are never anything but projections of present automatic processes and procedures, that is, of occurrences that are likely to come to pass if men do not act and if nothing unexpected happens; every action, for better or worse and every accident necessarily destroys the whole pattern in whose frame the prediction moves and where if finds its evidence.-- Hannah Arendt
Stock market history teaches us to be mindful and respectful of patterns but also to recognize the influence and importance of the unexpected.
Today investors, strategists and the business media seem to have a singular focus.
They are currently obsessed with forecasting when a taper will be introduced and are attempting to interpret its impact on the bond and stock markets.
When it is universally agreed that one factor (tapering) holds the key to the market, it likely means that that determinant is priced in (and so, I might add, is the likelihood of very dovish forward guidance coincident with the inevitable tapering).
According to a
survey of economists, there is a 34% probability of a December tapering, a 26% probability of January and a 40% probability in March.
My view is that a December tapering has almost a zero probability as there will be insufficient economic data to make the decision and it could potentially disrupt year-end funding and confidence (during the important holiday sales season). A more likely January tapering would encompass three full improving jobs reports, incorporate holiday sales results and there would be greater visibility of the outcome of fiscal debate in Washington.
As to interest rates (the second part of the riddle), that's a more interesting question.
Specifically, what level of interest rates would pose a risk to stocks (defined as a 5%-plus correction)?
Most view 3.25% or higher in the 10-year note yield within three months (indicating that yields have broken out of a two-and-a-half-year range and that forward guidance is not sufficient to hold down rates), 3.75% or higher within six months, 4.25% or higher within nine months or 4.5% or higher within 12 months as threshold points. My view remains that 3.5% or higher will be surprisingly negative for housing, the mortgage-backed securities market and potentially for the stock market.
Thus far, the capital markets have not been impacted by somewhat improving economic data.
In all likelihood, what will really move the markets over the next six to nine months isn't priced in at all right now.As mentioned previously, the consensus on tapering (it's schedule and market impact/importance) is more or less all the same -- that is, January or March in timing (67% chance) and basically not impactful and essentially irrelevant to the markets.
This is likely the natural outgrowth of a forgiving market with a strong degree of momentum to the upside that has ignored any potential headwind (economic, interest rate, geopolitical, political) throughout 2014.
Nevertheless, at this point in time, it remains probable that the market's consensus will prove wrong on its almost singular focus on tapering -- in the same way the crowd has been wrong in assessing the outlook for interest rates, the stock market and for asset classes over the past 12 months.
What a Difference a Year Makes
My yesterday was blue, dear
Today I'm a part of you, dear
My lonely nights are through, dear
Since you said you were mineWhat a difference a day makes
There's a rainbow before me
Skies above can't be stormy
Since that moment of bliss, that thrilling kissIt's heaven when you
Find romance on your menu
What a difference a day made
And the difference is you-- "What a Diff'rence a Day Makes," originally written in Spanish by Maria Grever (English lyrics by Stanley Adams), popularized by Dinah Washington
The rush to risk over the past 12 months and the performance of numerous asset classes have been noticeably at odds with consensus expectations and different than what nearly anyone expected a year ago. At year-end 2012:The markets were closer to being oversold; they are now severely overbought.
The outflow out of stock funds was at the highest level since the 2009 generational low. Throughout 2013, we have seen steady inflows into equity funds.
Wall Street strategists were well grouped to expect a modest rise in stocks (of 5% to 10%). Stock returns were 4x that this year. They were, as it is written, cautiously optimistic. Today strategists, though still relatively muted in forecast, have begun the one-upmanship of who has the highest
price forecast. At the very least, the bearish are being ridiculed, causing massive changes in expectations from strategists such as Adam Parker and, to be sure, the late exit/capitulation of nonbelievers and short sellers (e.g.,
). Even Cassandra-like Jeremy Grantham is positive on the markets over the near term.
Investor sentiment, cautious a year ago, has been replaced with sentiment being as positive as at any time in the five-year advance (based on the various sentiment surveys). Indeed, at a ratio of 4:1, the bull-to-bear ratio is at the highest level in nearly 25 years.
Technicals were unimpressive/uneven throughout the last half of 2012. Transports were in a downtrend that started in mid-2011, there were numerous breadth divergences that began in second-quarter 2012, and utilities were recovering nicely from a late-Summer fade. Today the technicals, a reflection of strong price momentum, are universally seen as the world's fair and supportive of continued market gains.
The 10-year U.S. note was yielding about 1.60% vs. nearly 2.90% today. Inflows into bond funds in December 2012 were at near-record levels. Today those funds are being disintermediated in accelerating fashion.
Emerging markets were at 18-month highs. In 2013, emerging markets have been conspicuous underperformers. The price of gold was near an all-time high (at $1,750 an ounce). The price of gold has crashed this year.
Most important, there was little attention paid to the
intention to continue QE/ZIRP ad infinitum. Today we are unduly attentive to Fed monetary policy and interest rates (nearly held hostage), which seem to weigh in all our decisions and in the market narrative.
Expect the Unexpected
Unfortunately, we don't find previous periods of slowing/ceasing Fed intervention worthwhile comparisons nor do we accept more dire forecasts of an end to the expansion. The economy is on much firmer footing today than 2010 or 2011 (although not quite solidly firm) while corporations have had several more years to right their ships. There is little doubt less accommodation will result in something although unlike others, we're not exactly sure what just yet.-- Dan Greenhaus, Chief Strategist at BTIG
This morning's opening missive is a long way of saying that a surprising influence (other than tapering or interest rates) will likely impact the markets in the year ahead.
I don't have a crystal ball, but it could take many forms.
On the negative side, it could be an unforeseen black swan event that no one is now considering or growing evidence that corporate profit margins are vulnerable to a regression toward the mean or it could just be that the market sells off because the demand has been sated.
On the positive side is that the forgiving nature of the market could lead to an upside blow-off sometime in 2014. Though sounding like a two-handed observer, I, not surprisingly, would say that reward vs. risk justifies a more cautious stand.
The great investors survive on that which is unpredictable -- the unexpected courses through their investing veins.In conclusion, I would search for factors other than tapering that will shed light on the performance of equities next year.
Expect the unexpected.
This column originally appeared on
Real Money Pro
at 7:52 a.m. EST on Dec. 9.
At the time of publication, Kass and/or his funds had no positions in any stocks mentioned, although holdings can change at any time.
Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.