A common concern among equity investors cited by Wall Street strategists is that the market is only being propelled higher by the Federal Reserve’s quantitative easing program, which has kept financial markets flush with liquidity for the better part of the past several years, and is driving an expansion in valuation multiples.
Now that the consensus opinion is that the Fed will begin tapering back QE as soon as September, the conversation is getting a bit more urgent.
Since topping out at an all-time high of 1709.67 on August 2, the S&P 500 index has fallen 2.8%, closing down in seven of the last nine trading sessions. A good portion of those losses are accounted for by yesterday’s 1.4% drop.
ConvergEx Group chief market strategist Nick Colas suggests that the markets are beginning to price in an eventual end to QE in a note to clients:
Let’s play contrarian, big time, and posit that the selloff over the past few days is meaningful, for it signals a return to something capital markets thought was dead: fundamentals. How many times have you heard over the last few years that U.S. stocks were the best show in town because the Federal Reserve was pushing liquidity into the system? OK — that overarching narrative is coming to an end with talk of ‘Tapering’ in September. Yes, I know they Fed isn’t abandoning the financial system just yet. But like so many Americans, their job in supporting capital markets will be shifting to a part-time engagement.
Colas points out that the fundamentals aren’t necessarily that great to begin with, but he argues that “U.S. corporations have done tremendous work in getting profit margins back to peak levels even as the domestic economy grows only slowly and the rest of the world is pretty punk.”
“Our message is more nuanced, and it comes down to ‘Fundamentals matter again’,” says Colas. “Forget the Fed.”