Bernanke has declared that all quantitative easing should be
tapered to zero by the end of 2014. But
Bernanke isn’t going to be in charge. We
cannot know what Yellen will do.
With nothing else to go on, though, let’s assume that the
taper follows Bernanke’s declaration.
Will the world end?
These three sites certainly think so:
But if you’ll look carefully at those sites, not one of them
is using any kind of model to show what the S&P should be under normal
circumstances.
By normal circumstances, I mean – driven by the economy. The market hasn’t had much to do with the
real economy since 2008. Oh, corporate
earnings are through the roof, but folks aren’t working.
So, what WOULD an economically driven market look like?
Ugly:
The basis for the “demographic projections” is the ratio of
working age to non-working age citizens.
I’ve used this ratio much like an Earnings Yield to develop a long term
Demographic Yield. If people drive
economic growth, then demographics can be used to estimate future growth based
on existing birth rate records.
The model works well from 1985 until 2009 – when Quantitative
Easing skewed valuations. Instead of
people creating money, Bernanke just started printing it.
But what happened to the people to throw us into a path that
could have led to another Great Depression?
To put it bluntly, the baby boomers aborted 50 million
babies and there aren’t enough people to pay for their retirement.
This would have looked like a Greek Tragedy had not Bernanke
pulled his Deus ex machina to
save the day.
I’ve measured the effects of QE in a previous post.
Basically, QE is the difference between that scary looking
red line and the happy blue line we’ve actually experienced. It’s like the difference between the red pill
and the blue pill in the Matrix.
In any case, now that we are facing the taper, what the HECK
should it look like?
For that, we need some hard data about the Fed’s balance
sheet:
Here’s a graph:
Until the economic crisis, the Fed balance sheet was
expanding at something similar to the rate of the economy. The average for 2003-2008 was 4.67% a
year. Then – BOOM! – by 2009 we had a
whopping 149% increase, and it keeps on going.
Just last year the Fed balance sheet increased by 38.74%.
If Bernanke’s taper prediction comes true, 2014 will STILL
see an increase in that balance sheet by another 13.96%.
After that, my best case scenario would be for the Fed to
maintain that balance sheet until 2024:
I’ve updated the S&P projection graph to incorporate
Bernanke’s proposed taper, and MY proposed maintenance of the balance sheet
until a 2024-2034 withdrawal.
The current projection also includes a normalized increase
in the balance sheet by 4.67% each year until that withdrawal.
Given those ideal conditions, we would see something like
this for the S&P (note the higher numbers from previous estimates to
include the entire projected QE):
2015
|
2050.71
|
2016
|
2101.69
|
2017
|
2326.07
|
2018
|
2508.94
|
2019
|
1763.98
|
2020
|
2360.19
|
2021
|
2149.77
|
2022
|
1862.23
|
2023
|
1480.70
|
Now you see why I suggest we maintain the balance sheet until
2024. Can you imagine the S&P back under
1500 even MAINTAINING the current balance sheet?
It would be far worse if they reversed all QE and worked
down that balance. The S&P in 2023
would be well below the March 2009 apocalyptic value of 666, and would likely go
post-apocalyptic to something closer to 400!
Let’s assume the good Janet Yellen isn’t fired in 2016 by a President
Rand Paul… and the sun and moon don’t fall from the sky…
Given that ASSUMPTION, there IS a slight demographic uptick
in the working age / non-working age ratio between now and 2018. That means we should have moderate economic
expansion.
Hence, the taper.
That is – the S&P could go above 2500 by 2018 even if we taper QE to
zero.
Of course, we do not know, and CANNOT know, what the Fed
will ultimately do. I’m only showing the
range of options between a sane taper and an insanely premature reversal.
I keep saying this, but cannot say it enough: don’t fear the
taper! Any REVERSAL before 2024 would be
disastrous – but no one is talking about that yet, and it won’t happen this
year or the next.
2016, though, brings another Presidential election. We elected a left wing ideologue, and we’re
surviving it. But please – no more ideologues. Too far to the left and we’ll get massive
inflation in the NEXT decade. Too far to
the right and we’ll get massive deflation in THIS decade.
If I were Bernanke, I’d be retiring too. At some point it’s beyond his hands.
And may God have mercy on Yellen’s soul.
But we’re okay this year and the next. We’ll have some scares, and I expect a good
correction to make most investors wet their pants. But the sky won’t fall, and the ground won’t
swallow us up – at least, not yet…
Now for some caveats:
These are just estimates on a model. I’m using the Fed balance sheet as a
multiplier on my own Demographic Secular Model.
This appears valid in the 2008-2014 time period, but that’s too short a
time to truly qualify as a multiplier on a secular model (which by definition
works in sequences of decades rather than years).
Even if valid, the numbers are mere approximations. As you can see on the first graph (above),
even the most accurate projections are never a bullseye.
You cannot, therefore, use such long term estimates to do
any kind of short term timing. I’m “timing”
in decades instead of years. We face the
continued threat of deflation in this decade, and the threat of inflation in
the next.
That’s really about as far as anyone can go. The purpose of this post is NOT to say what
the market must do, but rather to answer the common fears in recent articles
that the taper will bring immediate disaster.
Disaster would require something far more than a taper; it would require
full reversal of QE and an elimination of the Fed balance sheet – something which
must not occur until the 2024-2034 time period.
Tim
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