The Day Ahead: Taper Outbreak

 | Jun 20, 2013 | 8:00 AM EDT
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To taper or not to taper? That is the question posed by Sir Market. Taper up, taper down, taper sideways. Taper, taper, taper!

The other day, a producer friend and I discussed this question of when and how much the Federal Reserve will "taper" quantitative easing, and we agreed that every person on the Street has been transformed into a taper monster. Who's spreading this disease? It's Fed chief Ben Bernanke, of course, who surprisingly served a heaping of disappointment to Mr. Market. As for myself, I have put my money where my mouth is and since mid-May have clients overweighed in cash.

But, for those who believe all dips in the market are buying opportunities -- well, they were handed a rude awakening. First, we now have a general time frame as to when the Fed actually stands to taper, taper, taper. Second, we know when the Fed may finally signal the process of tapering beginning. Third, Bernanke appears to have broken with his Helicopter Ben mold. Fourth, all this is happening against the backdrop of those lame forward projections put forth by a bunch of people for whom we never voted.

Memo: These projections may be a load of manure, given that we have no clue as to whether economic growth could be self-sustaining, given the Fed's actions over the past few years. Reading the mood of the market, it's apparent to me that folks have no true belief in sustainable economic growth minus excess accommodation. So why bother paying up to hold equity in a company with cresting operating margins? Are you tapered out yet? I sure am!

Some more food for thought:

• Some budding logic says higher interest rates on U.S. Treasury bonds are great, fab, wonderful for stocks. Their mere existence, after all, means economic growth is acceptable. But, if you look at those Fed projections, the economy is at subpar recovery growth for the post-World War II period. The entire market isn't going to rip into the teeth of higher interest rates, because too few companies have global pricing power and have spent the past few years cutting capital expenditures as a percentage of total revenue in order to make an earnings number. That leaves fixed assets woefully prepared to drive innovation that, in turn, drives strong profits. Come on -- get real, folks.

• How in the world do higher interest rates help a company that wants to tap its credit line (which is normal) in order to build a new distribution center out in the middle of nowhere, aware that its near-term revenue is likely to remain weak?

• In a rising-interest-rate world, J.C. Penney (JCP) could go out of business. It will probably have to raise money in 2014.

• Higher interest rates will impact homebuilders that focus on affordable homes, which will then impact sales at Home Depot (HD) and then at Whirlpool (WHR). $FYI, the market is connected.

In sum, the market's slide Wednesday wasn't some knee-jerk reaction to the prominence of Wall Street gibberish, but because the market has realized the hole into which the Fed has dug itself. It's having trouble communicating an exit strategy, which leads to a pickup in volatility in the stock and bond markets that it desperately wants to grease.

Once the Fed actually begins to scale back its bond buys, the process of investing could get real ugly -- and, no, it won't necessarily be a function of rampant inflation. It's basic common sense tied to unwinding a massive experiment that has never been unwound before. All the while, the U.S. economy struggles to stay above 2% gross domestic product growth. This isn't doom-and-gloom stuff. This is me peering into the soul of the market, studying it tick by tick with research reports open on the third screen. For my client purposes, cash continues to be king, and your long positions should be absurdly researched and selective.

#HotTip Zone

I talked with J.C. Penney Wednesday, and it was a fun, informative conservation. Email me if you want details -- but suffice it to say that I think its fiscal second-quarter earnings call in August could be an interesting event.



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