December 16, 2013

Kass: Expect the Unexpected in 2014

Predictions of the future are never anything but projections of present automatic processes and procedures, that is, of occurrences that are likely to come to pass if men do not act and if nothing unexpected happens; every action, for better or worse and every accident necessarily destroys the whole pattern in whose frame the prediction moves and where if finds its evidence.

-- Hannah Arendt

Stock market history teaches us to be mindful and respectful of patterns but also to recognize the influence and importance of the unexpected. Today investors, strategists and the business media seem to have a singular focus. They are currently obsessed with forecasting when a taper will be introduced and are attempting to interpret its impact on the bond and stock markets.

When it is universally agreed that one factor (tapering) holds the key to the market, it likely means that that determinant is priced in (and so, I might add, is the likelihood of very dovish forward guidance coincident with the inevitable tapering). According to a Bloomberg survey of economists, there is a 34% probability of a December tapering, a 26% probability of January and a 40% probability in March.

My view is that a December tapering has almost a zero probability as there will be insufficient economic data to make the decision and it could potentially disrupt year-end funding and confidence (during the important holiday sales season). A more likely January tapering would encompass three full improving jobs reports, incorporate holiday sales results and there would be greater visibility of the outcome of fiscal debate in Washington.

As to interest rates (the second part of the riddle), that's a more interesting question. Specifically, what level of interest rates would pose a risk to stocks (defined as a 5%-plus correction)?

Most view 3.25% or higher in the 10-year note yield within three months (indicating that yields have broken out of a two-and-a-half-year range and that forward guidance is not sufficient to hold down rates), 3.75% or higher within six months, 4.25% or higher within nine months or 4.5% or higher within 12 months as threshold points. My view remains that 3.5% or higher will be surprisingly negative for housing, the mortgage-backed securities market and potentially for the stock market.

Thus far, the capital markets have not been impacted by somewhat improving economic data. In all likelihood, what will really move the markets over the next six to nine months isn't priced in at all right now. As mentioned previously, the consensus on tapering (it's schedule and market impact/importance) is more or less all the same -- that is, January or March in timing (67% chance) and basically not impactful and essentially irrelevant to the markets.