We are not buying the happy talk that investors have digested a winding down of QE and a potential Fed Funds Rate hike in late 2022 or 2023.
When the Fed begins to tighten (tapering of QE followed by lifting interest rates), markets will care. It is not logical to suggest that investors have largely digested forthcoming QE tapering and interest rate increases. Any uncertainty around QE tapering and interest rate increases is an opportunity to dislocate stocks from their current bubble valuation status. One thing is for sure, the longer the Fed waits on tapering and rate hikes, the more abrupt the Fed’s actions ultimately will be. For example, given the $28.4 Trillion (as of July 31st), in government debt outstanding and significant amount of short-term government debt it would be next to impossible for the Fed to take interest rates higher than 3% without reducing outlays to Entitlement Programs. However, despite this interest rate ceiling (our guess is that the eventual rate ceiling will be around 2%), nobody knows what the slope of rate increases will be – including the Fed. Thus, it is impossible for the markets to have perfect information regarding rate hikes and this uncertainty will be met with selling – which is always how investors deal with uncertainty. That giant sucking sound you will hear once the Fed tightens will be investors rotating out of equities into fixed income securities – and that’s on the institutional side. Our guess is that on the retail investor side many retail investors will ride their equity positions down and ultimately get out of equities – for life. This retail investor behavior would be in-line with the dot.com bubble of 1999-2000.