The Fed: What Happened Next…

A month ago in “The Fed: What’s going to happen next? I suggested that you might consider that it doesn’t matter what the Fed does – it only matters how the drivers of price react to it. I went on to explain that we don’t need to know what the Fed would do but instead how the market responds to it. And, the market may not respond the way you expect. Trying to figure out what to do next based on what you think the Fed is going to do is a tough way to make portfolio management decisions. Prior to the announcement, it seemed the worry about it was based on what they would do, but all that really matters is how the price trends evolve of the positions you hold.

Most market participants didn’t seem to expect a taper. And, if a taper were announced, most seemed to expect stock prices would decline. After all, this Quantitative Easing program has been going off and on for several years now and when they’ve stopped it, stock indexes quickly dropped 10 – 20%. You may recall those declines in 2010, 2011, and 2012. Based on that historical precedent, it seemed to suggest stocks could be expected to fall when the Fed finally begins to unwind it’s massive bond-buying program to stimulate the economy. And, at some point it could even be a very significant decline since it appears this QE program has been a driver of stock prices since the 2009 low.

Later that day, the Fed announced that it would indeed begin to “taper” its bond-buying program. Although, The Federal Reserve’s $10 billion taper announcement doesn’t seem a significant cut in the central bank’s massive bond-purchasing plan. It’s still a taper and a taper is what those who talk on TV and write about it seemed to be afraid of. In fact, I mentioned in Fear is beginning to drive stock trends that investor sentiment measures shifted to fear and prices had dropped about -3% leading up to the Fed announcement. It seemed the market had anticipated some negative news and their fear “priced it in”.

Yet, the stock market index actually rose on the announcement instead of down. Maybe they overreacted leading up to the news and prices drifted back up.

stock market rally since fed taper announcement

In the chart below, we show a chart of global market prices since the taper announcement. Clearly, most global markets actually drifted up including the S&P 500 stock index ($SPX), U.S. Dollar ($USD), Developed Country International stocks (EFA), and even Long Term U.S. Treasuries (TLT).

global market returns since fed taper announcement

Commodities like the GSCI Commodities Index (GSG) and Gold (GLD) immediately declined, since commodities and gold typically trend inversely to the U.S. Dollar. And, Emerging Markets countries (EEM) have trended down – maybe because many of them are commodity producers.

Things don’t always turn out the way you expect, so having strong expectations about what’s going to happen next can make portfolio management very difficult. In fact, having strong expectations that reach the point of convictions lead to overconfidence and ego issues that causes one to stay with their losing positions. When you stay with losing positions, hoping they’ll turn around and prove your right, you get caught in a loss trap. That’s how you lose a lot of money.

I find an edge in going with the flow, the current trend, what is actually happening. It seems if we do that, we can never be wrong for too long. It’s OK to be wrong; it’s staying on the wrong side of the trend that becomes a problem. And doing that starts with too much beliefs and expectations about what’s going to happen next and being unable to reverse it.

Flow… just go with it.

When we know in advance what we’ll do next, we don’t have to try to predict in advance what’s going to happen next.

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