Last Week in Brief: December 13

December 17, 2013

Expectations of Fed tapering sent markets lower last week. Dominating all opinion is the "What's good for the economy is bad for the market" mindset. This mindset is predicated on the idea that, as the global economy improves and the Fed begins to pull the stimulative punch bowl from eager partygoers, the market will collapse.
And you know what? They could be correct. Yet, history both supports and refutes this point of view.
We've seen the market sell off for such reasons three times these last four years. In 2009, 2010 and 2012. Each time, the culprit was the announced or perceived ending of QE1, QE2 and Operation Twist. Though, each episode was followed by additional stimulus. Which caused markets to rise.
Eventually, Mrs. Yellen's Fed will terminate tapering, and raise interest rates. Impending destiny (Yes, it's redundant. But that's how assured it is.).
There are two storylines. Both are correct.
On the one hand, the Fed's balance sheet is bloated and unseemly. And while its cleaning may involve complications yet unseen, it must be done.
On the other hand, the Fed's dual mandate supports additional easing. Because inflation is in check. And employment remains weak.
Still, tapering and its siren sister, the termination of QE, must be courted. And eventually, dated seriously. Leaving investors terrified.
Amid all the bearish caterwauling, Hamlet serves us well. For perhaps, these bears doth protest too much, methinks.
Historically, markets have shown that they can rise with interest rates (here). So, though the world is expecting the market to fall apart completely when the QE ends, the world has been wrong before.
The Good
Congress reached a budget deal? Political consensus in the flesh? Spank me cross-eyed, I didn't see that coming!
Now, this was tactical for the GOP, which did not want another budget fight to muddy the waters prior to next year's midterms. The GOP needs the midterms to become a tribune on ObamaCare. To that end, they're willing to do anything. Even compromise.
This provides good news for the economy, as the deal will shrink the deficit so long as tax receipts from higher incomes continue to increase.
This is positive for investors. We enter the year without the uncertainty of another potential capital crisis. Could even open the door to immigration reform. It also shows that the far reaches of both political spectrums could be losing some of their luster, as Speaker Boehner could never have achieved this a year ago.
Now, back to more important items. Like shopping. Retail sales beat expectations. In fact, most economic data points were positive. The global economy is on a slow mend. As are individual household balance sheets. More growth and less debt? Yes please.
Finally, Stanley Fischer will be nominated for Yellen's former position, the deputy Fed chair. He's a bit of a Keynesian. Still, a really solid guy, and likely the right man for the job (here).
The Bad
Investors Intelligence reports that bullish sentiment rose to its highest level since October 2007. Which is frightening. Because when fear dissipates, so do equity returns.
Nelson Mandela passed away. What a remarkable man. Humble. Visionary. Focused. Genteel. His words came in whispers. While his actions roared from the heavens. Check out this beautiful tribute to the man by the Soweto Gospel Choir.
The Bottom Line
All eyes remain on the Fed. Taper? No taper? Who the hell knows? It is growing tiresome. As tiresome and as boorish as Al Gore's repeated forecasts that the polar ice caps could be gone by 2014 (here). For the record, the ice caps have never been thicker. Nor, for that matter, has Al Gore's wallet.
Weekly Results
Major markets finished lower last week. The DJIA fell 1.65%, the S&P 500 lost 1.65%, and the Nasdaq dropped 1.51%. Small cap stocks declined 1.25%. And the 10-year Treasury bond yield gained 1 basis point to 2.87%. Gold gained $9.21 per ounce, up 0.75%.
We've been pushing small caps as an area of outperformance. And outperforming they are. The Russell2k small-cap index leads the S&P 500 by 9 percentage points over the last year. Booyah!

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