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... And Now Comes the "Santa Claus" Rally

By Costas Bocelli December 18, 2013 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Well, kudos to the Fed for finally ripping the Band-Aid off.

In their final policy statement of the year, the FOMC announced that it will taper the size of their monthly asset purchases from $85 billion a month down to $75 billion starting in January.  The reduction will be evenly split -- $5 billion each -- between longer-term treasuries and mortgage backed securities.

The stimulus program which has been running since September of 2012 has added to the Fed’s balance sheet at a pace of $1 trillion a year.  And since early summer, the Fed has been telegraphing its intentions to cut back on the QE as the labor market and economic data have been showing encouraging improvement.

But the actual announcement to curtail the program has been somewhat elusive, which has created a cloud of uncertainty across many asset classes and global markets.

In fact, an overwhelming number of prominent economists were quite dubious that the Fed would make a tapering move at the December meeting.

If you recall last week’s article (Here Comes the Taper), we actually made the case that the Fed would announce a taper in the December policy statement.

We tossed aside the wonky economist cap and donned our trader jersey in coming up with a solid argument as to why the Fed would indeed make the move now rather than wait.

As it turns out, it was the right call. 

And as an experienced trader, going against the crowd is not uncommon so long as the logic makes sense -- even if it means taking a contrarian view from a bunch of Ivy League economists and highly accredited PhD’s.

We also suggested last week that if the Fed should happen to announce a taper at this policy meeting, it would likely result in a bullish reaction.

“The reality is that the market has already discounted the fact the Fed will soon taper QE, so if the FOMC announces a taper next week, that should ultimately be seen as a positive response.”

“So rip the Band-Aid off and just get it over with.  That would likely send the markets to yet another new high as more uncertainty is lifted from the market landscape.”

Once again, we were on the right trail, because it looks like the major averages are on the verge of another breakout.

Bernanke Dons the Santa Suit

While the Fed did announce a modest reduction in their monthly asset purchases, it didn’t come without a holiday present.

You see, the committee also announced an adjustment to their forward guidance on the direction of short-term interest rates.

“The Committee now anticipates, based on its assessment of these factors [price inflation targets], that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.”

Essentially the Fed tweaked their language by adjusting the market's expectation on when short-term interest rates could be raised.  The prior language suggested hitting 6.5% on the unemployment rate would be the threshold for considering a hike in rates.  The new statement now implies that once 6.5% is reached, interest rates will remain pegged to zero for even longer.

And that’s the real driver of easy central bank policy -- even with the reduction to its QE asset purchase program.  As long as liquidity continues to be readily accessible, lower interest rates for longer will be music to the stock market’s ears.

And it was that little -- but significant -- tweak that resonated on Wall Street.  It reversed modest losses before the Fed announcement into broad based gains over the final two hours of yesterday’s session.

And it indeed turned out to be a record breaking day.  The Dow rallied nearly 300 points and recaptured 16,000.  The S&P 500 also made a new all-time high too -- the 40th record closing print of the year!

The index has been consolidating its gains around 1800 for nearly a month.  And now with the budget bill soon to become law and the Fed lifting another veil of uncertainty, stocks are set up for an early Santa Claus rally that will likely extend into the New Year. 

The calendar looks bullish until Washington is forced to confront the debt ceiling issue in a couple of months.

Until then, the bullish trend remains long and strong...

My best wishes to you and your family for a happy holiday and a wealthy and healthy New Year!

S&P 500 poised to close 2013 on a strong bullish note...