When Fed chairman Ben Bernanke gave his press conference yesterday to talk about upcoming Fed moves and the central bank’s view of the economy, guess what sent the markets into a fall?
He didn’t say “crash.” He didn’t say “doom.” He didn’t even say “interest rate hike.”
“Markets stumbled when Chairman Bernanke used the word ‘optimistic,’” says Quincy Crosby, market strategist for Prudential Financial. “Markets, being what they are, say ‘sell first ask questions later.’”
Whiskey Tango Foxtrot? You may wonder.
Think of the economy over the past few years as a party -- a really sucky party. The deviled eggs taste questionable (consumer confidence was low). There’s nobody you want to go home with (unemployment has been stubbornly high). Everyone is on their phone (people aren’t investing), and the guests are showing each another their stamp collections.
How to turn that into a fun party? BOOZE! (Quantitative Easing!)
So, like a much-needed liquor run to spike the punch bowl, the Fed has been pumping money into the economy by buying $85 billion worth of bonds and securities every month. It gives banks more money to lend so businesses can get loans. It helps keep mortgage rates low (buying mortgage backed securities). It discourages people from buying bonds (buying so many the price goes up), and encourages them to buy stocks or other more risky investments that can help the economy.
Result? The party is rocking. People are swinging from the chandeliers and puking in the bathroom. The economy has, theoretically, been improved -- and a lot of investors have put money into stocks.
So back to the “Optimism” thing. If the Fed is optimistic, it means -- as it said -- that it would let up on the quantitative easing. start putting less liquor in the punch bowl.
But if you're an investor, here's the rub. “There is this belief that the fed’s pumping of liquidy into the system has helped drive up the prices of stocks,” says Dan Greenhaus, chief global strategist for BTIG.
So now you may be afraid that your stocks, which have done so well, (up 140 percent since 2009 and it’s been several months since any kind of major correction, according to Ed Clissold with Ned Davis Research) are overvalued. And you think perhaps it’s time to cash out before they fall when the Fed slows things down. “On the idea that the fed would provide less liquidity, investors are using this a chance to sell some of their holdings that have presumably gone higher [than they otherwise would].”
As Mark Spindel with Potomac River Capital says, “The party isn’t over, but people have figured out the party’s ending.”
Clissold, with Ned Davis Research, says in the past, the Fed has eased up its previous rounds of Quantitative Easing a little too fast, and the economy has gotten bogged down again. Which is why Bernanke went to such great lengths to describe how well things are going economically. “The Fed has been very deliberate in saying they’re going to do this when they feel comfortable that the economy can still grow in absence of Quantitative Easing,” says Clissold.
Does this mean the stock market knows something about the economy that we don’t? No, says Mark Spindel with Potomac River Capital. “The economy should continue to do fine," he says. "But I think the investor base is a little bit more demanding and maybe a little less patient.”
This sort of correction happens any time there’s a major policy shift, says Quincy Crosby with Prudential Financial. And hopefully, the party will go on.