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Pension Partners' Gayed: What If the Fed Is Wrong?

By Michael Kling   |   Sunday, 09 Feb 2014 06:32 PM

Conventional wisdom holds that the economy must be improving because the Federal Reserve is tapering its bond-purchasing stimulus. The Fed, in its wisdom, wouldn't be tapering its quantitative easing stimulus if the recovery wasn't on solid footing, right?

Yet no one is thinking that the Fed could be wrong, writes Michael A. Gayed, chief investment strategist and co-portfolio manager at investment adviser Pension Partners, in an article for MarketWatch.

The Fed may be leaving the QE game not because it thinks it won but because it realizes the stimulus wasn't effective. After a year of buying $85 billion of bonds a month, the central bank doesn't have much to show for its effort. Where, Gayed asks, is the robust economic rebound?

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"Should we not be seeing payroll data dramatically ahead of expectations? Shouldn't manufacturing data be soaring?" he asks.

Evidence that the recover is approaching escape velocity is not evident in recent economic figures, he says.

"While many are blaming the polar vortex, markets are looking beyond that. This is not about the weather."

The U.S. stock market boomed in response the Fed's quantitative easing stimulus — "the Fed put" — while investors ignored slow global economy growth and other problems, Gayed says.

"Emerging-economy export activity has been weak, commodities prices have been pressured, and developed equities have divorced themselves from inflation expectations purely because of complete faith in the Federal Reserve."

Gayed notes that U.S. small-cap stocks substantially outpaced the S&P 500 as investors bet heavily on the domestic economy. That recently reversed in a big way, as small caps sank.

"When small caps underperform large caps, it means the market is placing a premium on global growth over domestic growth," he explains. "But if there is no acceleration in global growth, then weakness in small caps is really a bet on a weakening domestic picture."

That, he says, contradicts the conventional story line of an accelerating recovery.

Fed officials say falling stock markets probably won't stop them from reducing their bond-purchases by $10 billion at upcoming policy meetings. "The hurdle ought to remain pretty high for pausing in tapering," Richmond Fed President Jeffrey Lacker said after a speech in Winchester, Va., according to Bloomberg. Chicago Fed President Charles Evans also said pausing the taper faces "a high hurdle," Bloomberg reports.

Most economist surveyed by Bloomberg said the U.S. recovery is strong enough to survive the recent stock market downturn.

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