The market is acting odd. Ben Bernanke is hinting that he is going to scale back the loose monetary policy that has, theoretically, been supporting the US economic expansion. He is hinting at the change because he thinks the economy is reaching a level of stability that growth can continue with more normal policy out of the Fed. The improving economy would usually be a good news story for stocks; the most knowledgeable economist in the country thinks the economy is getting better – how is that not good news?
Well, sometimes when economic growth picks up, it results in higher levels of inflation, and that inflation can have a nasty impact on stock price. However, that doesn’t seem to be the case this time around. In fact, inflation expectations are falling, not rising; so inflation doesn’t explain what’s going on. What seems to be happening is a fundamental disagreement between investors and the Fed. The Fed thinks it’s safe to stand up and walk around the plane, while Wall Street thinks we need to keep the “fasten seat belt” sign lit, and to keep it fastened tightly! Wall Street’s concern is that if the Fed is wrong, and if they withdraw support too fast, the economy could slip back into recession.
We don’t envy the Fed’s position. If the Fed continues with their bond-buying, the chorus of Wall Street pundits will scream about inflation. If they take off the safety belt sign, the chorus screams about recession. It seems like a lose-lose situation, but in the end it doesn’t even really matter all that much. The markets are choppy, and always will be. The proof of the direction of the economy will be in the numbers: are companies earning more? Are people getting back to work?
Bernanke knows what he’s doing; if the numbers don’t demonstrate continued growth, he’s not taking the seat belt off. So, while there is a lot of turbulence right now, we don’t think we will go flying out of our seats anytime soon.