Sunday, October 27

Welcome to the 'Dirty Harry' market

| By Jim Jubak

The Fed is no more out of ammo than Clint Eastwood in his prime. And with the economy looking shaky, don't bet that it will pull back on stimulus anytime soon.

As I look at the U.S. and global financial markets right now, I keep thinking of that iconic scene in “Dirty Harry.”

Clint Eastwood is facing a piece of urban pond scum whose own gun is on the ground but within reach. Eastwood has got him dead in his sights, but after a running gun battle, he could be out of ammunition.

“I know what you're thinking,” says Eastwood’s detective Harry Callahan. "‘Did he fire six shots or only five?’ Well, to tell you the truth, in all this excitement I kind of lost track myself. But being as this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question: ‘Do I feel lucky?’ Well, do ya, punk?”

Investors face a similar situation now as we try to decide if the Fed is out of the ammunition it has used to prop up the economy.

You recall the scene. The punk decides Harry’s gun is empty, reaches for his own and winds up floating face down in the midst of a spreading patch of bloody water.

While not wanting to suggest that either you or I are equivalent to Dirty Harry’s punk, I do think Eastwood’s question is appropriate for us now.

The Federal Reserve, the People’s Bank, the European Central Bank, the Bank of Japan and other of the world’s central banks have fired a lot of ammunition -- first, to head off banking system meltdowns, and second, to try to stimulate their economies into sustainable growth. Global financial markets rallied on that action with some stock markets -- the U.S. and German markets, for example -- moving up to all-time highs and already low bond yields falling even lower as bond prices moved up.

Now, with global growth rates nothing to write Sister Sara about, with politicians in Washington D.C. about to begin another round of budget negotiations that may make “Riot in Cell Block 11” look like a shining beacon of good faith, and with some economies showing all the emotional bounce of the pod people in “Invasion of the Body Snatchers” (to continue and conclude this post’s Don Siegel homage), financial markets are rallying again on hope that the central banks have more bullets left in their gun.

Jim Jubak

Well, do you feel lucky? And if you do, for how long?

Let’s be clear, I hate investing when it resembles gambling. I like markets with clear macro trends behind them, such as the falling yields that characterized the bond markets since the early 1980s. (That trend is over now.) And I like markets without trends and where the fundamentals drive individual stocks.

But I really dislike markets where the direction of macro trends is up for grabs; where traders and investors are trying to bet that that they can guess the results of an essentially binary decision; and where the results of that binary decision -- in the latest case, a taper/no taper decision by the Federal Reserve -- will drive most drive stock prices in one direction or another, overwhelming the fundamentals of the vast majority of individual stocks.

That’s exactly where we are right now.

Which is almost certainly good news through November and into December. After that, though, I’ve got to wonder how lucky we’ll be and for how long.

The consensus opinion on Wall Street at the moment is that the Federal Reserve’s Open Market Committee, the group that will decide when the central bank will start to cut back on its current $85 billion in monthly purchases of Treasurys and mortgage-backed securities, won’t start the taper at its Oct. 30 meeting. The thinking is that the Fed won’t have enough data on the economy to decide if U.S. growth is strong enough to stand up to a withdrawal of some of those purchases. It’s not the direct effect on the economy of cutting purchases to $70 billion or $75 billion a month that concerns the Fed, but the effect of any follow-on increase in interest rates and the potential that higher rates might slow sales in sectors of the economy, such as housing and autos, that rely on financing.

Since there is no Fed meeting in November, the earliest that the Open Market Committee could begin a taper of the Fed’s purchases would then be the Dec. 18 meeting. But the Wall Street consensus is that the Fed won’t act at that meeting, either. That consensus is based on the belief that the government shutdown and the debt-ceiling crisis whacked something like 0.6 percentage points out of annualized GDP growth for 2013. That translates into a drop in annualized growth in the fourth quarter from a projected 3%, according to estimates by Standard & Poor’s, to 2%.

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