Tapering and the Markets
Given the parameters set forth for tapering (strong employment, economic growth, etc...) I feel like the economy/stock market should react favorably upon the announcement of the Fed doing so. However, what we saw in September was a brief rally in the stock market when the Fed chose not to do so.
I'm curious as to why this is. I'm looking for any insight or comments that people have on the topic as I'm somewhat confused. Thanks!
You have to understand what the market participants are using for valuation metrics. When the Fed says it is deciding to taper, (or perhaps reneging on efforts to taper), information is given. In the case of the taper, information is that the economy has feet, and that its sustainable given the absence of excess fiscal and monetary policy. A very simple (perhaps overly simple) metric to understand the current market is the Gordon Growth Model. The Federal Reserve is lowering interest rates, which many people see as raising market valuations (Shiller's PE ratio would agree).
The additional information contained in a possible Fed taper means that growth is going to rise or at worst stay the same, but rates will increase. The incremental rise in rates outpaces the perceived rise in growth rates, and thus valuations will have to fall in that model. Hope that helps!
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