Selloff? What's that? $$
— Jesse Felder (@jessefelder) February 20, 2013
The stock market has done a fabulous job making us forget what it feels like when stocks go down (in fact, this is one of the reasons I “turned bearish” last week). So when it declined by a little more than 1% today it probably felt like a lot more than that to a lot of folks.
You can point to any number of reasons for the selloff: Caterpillar’s declining sales report, the weak housing starts number, falling commodities (see Dr. Copper), etc. What really spooked the market, though, was the revelation that the Fed may not support asset prices forever. The Fed minutes released today hinted that the central bank may not wait for the jobs market to improve before removing to some degree the amount of accommodation it has been providing the asset markets.
I’ve written about this a few times over the past few months because it’s my biggest worry. The Fed has been teasing and taunting investors for four years now into playing its confidence game. In the process it’s inspired a whole new breed of investor whose purchases are totally reliant on the Fed backstopping them in everything from real estate to stocks, junk bonds to gold.
But what happens when the game’s over – when the central bank decides it can no longer afford to spend trillions of dollars of money it doesn’t have to support asset markets that have already soared in price? Or, worse yet, what if investors lose confidence in the Fed’s ability to stimulate or support the economy and asset markets? This is the single largest risk to asset prices right now: confidence in the Fed.
Pop quiz: the chart below tracks the price of what?
If you guessed the Nasdaq 100 you’re pretty damn close. It’s actually a chart of the Dow Jones US Homebuilders Index for the 3 year period beginning in 2003 and ending in 2006. In 2007 it broke down and declined almost 90%.
Here’s the chart of the Nasdaq 100 for the 3 year period beginning in 2010 and ending today. The right shoulder is not fully formed yet but you can bet every trader has turned his undivided attention to this chart. As should you.