Market Lab Report - To taper or not to taper...

Market Lab Report / Dr. K's Crypto-Corner

by Dr. Chris Kacher

To taper or not to taper...

The CPI in December jumped 7% from a year ago, below the 7.1% estimates. This was its highest level since Feb 1982. Core CPI hit 5.5% from 4.9%. And this is so despite the grossly manipulated CPI. Stock and crypto markets rallied because the number was below estimates. On a monthly basis, the CPI climbed 0.5% in December vs 0.4% estimates.

Powell's testimony on Tuesday was as expected. As we know, he's very good at appeasing both sides. He said that the economy is both healthy enough and in need of tighter monetary policy yet also said he anticipates rates to remain low for the foreseeable future. This implies eventual interest rate hikes, continued tapering of monthly asset purchases, and a smaller balance sheet. Bottom line is inflation is still spiking which will force tightening so the recent bounce in the stock and crypto markets is likely to be short-lived.

Indeed, Powell stated, “As we move through this year … if things develop as expected, we’ll be normalizing policy, meaning we’re going to end our asset purchases in March, meaning we’ll be raising rates over the course of the year,” he told committee members. “At some point perhaps later this year we will start to allow the balance sheet to run off, and that’s just the road to normalizing policy.” He said he would continue to monitor the data to guide his next move, thus leaving open all possibilities.

Both stocks and crypto have been oversold so any excuse to bounce should not come as a surprise. Price/volume action in the NASDAQ Composite, S&P 500, and the two crypto juggernauts BTC and ETH on this bounce has so far been relatively anemic.

Real alpha is made by anticipating. But given the number of factors at play, this is easier said than done. For example, Powell gave clues that he would maintain a hawkish stance a month ago when he removed the word 'transitory' with respect to inflation. Markets sold off. But then they bounced into the start of the New Year. The Fed minutes published on January 5 which shows their thinking at their earlier meeting, showed a continuation of this hawkish undertone, so markets once again sold off.

Given that the data such as the CPI is grossly manipulated and not representative of reality, and given that Powell and other top officials have much of their wealth tied up in stocks and real estate, Powell will not want to cause a crash. He's demonstrated this behavior since QE began in late 2008. Each time the major market averages start into a more serious correction beyond -20%, he appeases markets by reversing his hawkish position. Powell cannot pull a Volcker because today is massively different than when Volcker was the Fed chair. Times change. Debt in the U.S. alone is even greater than during WW II. Interest rates are at 5000 year lows. Back in the 1980s, Volcker's hawkish stance which sent interest rates to record levels did not crash the stock market, but instead induced a typical bear market where major averages lost about 1/3 of their value.

Nevertheless, the narrative has changed from dovish to hawkish as represented by a few major central banks having hiked or planning to hike interest rates. Inflation has spiked forcing this narrative. So if we get a standard -20% pullback in the major averages, that is still about a -14% drop in the NASDAQ Composite and -18% in the S&P 500 from current levels at the time of this writing. You would then expect many stocks with their QE-elevated PEs to pull back well beyond these percentages.

Still, don't expect a straight line lower. The largest factor is QE which is still flowing. Other banks dance to the tune of the U.S. central bank, though inflation has gotten away in some countries forcing their hands to hike interest rates. But history has shown that there will be yet another crisis which forces M2 higher. This will force those central banks who hiked rates to stop or reverse their tightening programs. Such crises are likely to be the result of higher order effects from supply chain breakdowns due to debilitating regulations brought on by C19, lockdowns, and other restrictions. This will further hamper economies. M2 historically does not contract when debt reaches onerous levels. Central banks will use any excuse to digitally print money.