Tale of the Tape…

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By Jeremy Office Special to The Pineapple Here we go again. We have another term introduced to us from the media and Federal Reserve. Not only have we added, “Quantitative Easing,” “Fiscal Cliff,” and “Sequestration,” to our financial jargon, but we now also have the term “Taper.” Over the past few weeks we have been inundated with alliterations and puns regarding the taper that economists are calling for in September. “Taper Talk,” “Septaper,” “Taper Tip-Off,” and the “Taper Tantrum,” are all buzzing on financial media outlets. ….but what is the “taper” and how will it affect the economy and markets? The term “taper” is used to describe the reduction of bond-buying by the Fed through the stimulative quantitative easing (QE) program. So far this has boded well for investors. We’ve reached all-time highs in equity markets this year and we’ve seen the housing market start to rebound. For the past few months Fed Chairman Bernanke has remained adamant that the continuation of the bond buying program is dependent upon incoming economic data. In his June statement, Chairman Bernanke announced that the Fed would “gradually reduce purchases beginning later this year, and ending next year when the unemployment hits 7 percent.” In turn we saw an overreaction of investors selling out of bonds which sent yields spiking in the aftermath. The latest jawboning from the Fed has been the topic many economists, strategists, and pundits have been trying to decipher like the Da Vinci code. I don’t remember a time where there has been so much emphasis on what the Fed was saying to provide clarity on the direction of the market. Regardless of who breaks the code, it’s not a matter of if the Fed begins to taper, but when the Fed begins to taper. Some argue that the sequester spending cuts, higher tax rates, and further potential negative economic impacts from policy decisions made during the upcoming budget and debt ceiling debate are likely to keep economic growth somewhat suppressed through the end of this year. All of which will make it more difficult to justify the Fed taking their foot off of the gas pedal. Some even feel the Fed should provide additional stimulus by spending money on job training, infrastructure, and R&D to benefit those who have not benefited from stock market gains and the rise of real estate prices from QE. If we cannot obtain significant growth under the current program, how can we do so without QE? Others believe that now would be an ideal time to begin to taper, citing an outgoing Fed Chairman, reduced deficit, recovering (slowly) economy, and declining jobless claims. They also argue that the benefit of more quantitative easing does not outweigh the costs and can potentially fuel another asset bubble. The intended effect of spurring GDP growth has been lackluster and QE continues to build excess reserves in the banking system that could potentially be inflationary and there is no real value to keeping QE going. At Maclendon, we believe tapering will not occur after this months Fed meeting. GDP growth is not where it needs to be, unemployment remains high, core inflation is below the Fed’s target and after the latest rise in interest rates due to tapering speculation, any further rise will be a headwind to capital expenditures and the housing market which could further stall the economy. Throughout each variation of QE you can see that the markets have reacted favorably. If the Fed were to taper, we believe this would be a major headwind for the markets for the remainder of year. Although we believe tapering in September would be a little premature, we feel it is a necessary step in the future for a sustainable economy. If the Fed does decide to taper in September, it would still remain highly accommodative. We cannot continue to prop up the markets forever without unknown consequences in the future. We can only hope the Fed has the foresight and monetary tools needed to remove liquidity from the system before the next crisis occurs. Jeremy Office, Ph.D, CFP, CIMA, MBA is Principal at Maclendon Wealth Management in Delray Beach and specializes in portfolio construction, strategic asset and liability management, and long term planning relating to financial matters as well as real estate, income tax, insurance and estate planning. He is also Managing Partner of SJO Worldwide a venture capital company. www.maclendon.com • 855.MAC.WEALTH