The Fed Hints at a Sea Change

 | Jan 04, 2013 | 7:51 AM EST
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Yesterday's home runs don't win today's games. --Babe Ruth

As the new year starts to unfold, the big question for us to ponder is whether the action will look similar to what we've seen the last few years. The most notable feature in this period has been very streaky trading, driven primarily by central bankers and politicians.

Individual stock-picking has often been fruitless, given that shares have tended to move in a correlated fashion. In fact, this sort of action has become so obvious that the media has adopted the phrases "risk on" and "risk off" to reflect that the only thing that really matters in the market is timing.

On Thursday afternoon we got a small hint that things might change in 2013. In the minutes from the last Federal Reserve meeting, there was some discussion that quantitative easing may cease before the end of the year. That would be a dramatic change, as nothing has been a bigger market driver over the last few years than QE.

Unfortunately, we will very likely have to deal with a political battle over the debt ceiling in the coming months, and there is also a great likelihood that the European sovereign-debt issue will raise its ugly head one again. Still, a change in the QE program will have more impact than anything else, and we will need to watch very closely for developments in that area.

One thing that is very likely to impact the Fed's decision on QE is the unemployment rate. The central bank has made it clear that its policy of very low rates will continue as long as joblessness remains elevated. Some question whether the Fed policies really do anything to impact employment, but the Fed apparently thinks so, and that is all that matters.

The reaction to the jobs news this morning will be interesting. For a while now, bad news has been good news, as it's kept the Fed's printing press running. On the other hand, positive news has also been good, as some economic improvement is always welcome -- so long as it doesn't cause interest rates to rise. When the market starts to sell on good news, we will know inflation worries may be kicking up, and that the Fed will likely feel it must back off.

For years now, the one simple adage that has mattered more than anything has been, "Don't fight the Fed." When the Fed starts to back off on QE, the whole nature of the market will change. So we need to watch the response to data, as in jobs growth, to see if the market is starting to anticipate a Fed move.

The emotions surrounding the "fiscal cliff" agreement and the start of the new year are going to cool off quickly now as we start to anticipate fourth-quarter earnings reports. Alcoa (AA) is due to kick off the onslaught next week, but the big reports don't start to roll in for another few days. As you'll recall, third-quarter reports were weak, and quite a few stocks struggled. As a result, expectations are pretty low; but hopefully we'll see some new leadership emerge and a boost for stock-picking.

After the fast start by the indices, there is plenty of performance anxiety out there right now, and that is likely to give us some dip-buying support. But market players took the Fed minutes as an excuse for profit-taking, and they may do so again on the next headline number.

I'll be looking for some long buys after market open, but I'm hoping for some backing and filling. That would provide for some better setups, as many things are currently extended.

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