Rally On, Bull

As soon as the Fed tapering talks died down a U.S. government shutdown comes. This year has definitely not been short of excitement! 

The confusion in the markets is quite surreal - the equity markets rallied and treasuries sold-off post-government shutdown, which is initially counter-intuitive, because, shouldn't people be scared of a world where Americans can't visit their national parks and see pandas live on the internet? Some are arguing that the cause of the equity market rally is that this shutdown will prolong easy money from the Fed, helping the markets extend their rally:

"We do not know how long this impasse in the U.S. will last. If it persists, there is a chance it will hurt economic growth and affect chances of Fed tapering," said Daragh Maher, strategist at HSBC. Source: Reuters 

I have to biased-ly agree on this (see my previous post on delayed Fed tapering). This is definitely going to hurt the economy, and the damage will extend beyond the humorous shut down of the panda live cam. Easy money will continue.

In terms of implications for the markets, this turn of events is extremely confusing and even more ambiguous. On the one hand you have expansionary monetary policy with the Fed continuing QE3 and low interest rates, and on the other hand you have a contractionary fiscal 'policy' (or rather, 'failure'!) where the two parties are jockeying for political position at the expense of the citizens' livelihoods. So in the end the status quo continues: easy money in the market, higher equity valuations, but an economy that continues to stumble along. At some point these two trajectories will change directions and that's when I foresee a turn in the equity markets. Below is a simple picture of how I imagine this will all end up in the next 2 years.

At the point where the two lines intersect is the situation where the equity markets will have far outrun the growth in the economy, and become irrational just as easy money gets taken out of the money by the Fed. The most likely scenario at that point will be a market crash.

In the near term, I think easy money will prevail and it's most likely that the equity markets will continue on their upward trajectory this year. Some kind of market pullback is warranted as the economy remains tepid due to the fiscal budget while market valuations have run since last year. However, judging from all that I read I just don't feel that we are at the euphoric phase of the bull stock market just quite yet; the Fed has continued to distort and fuel the markets. Get ready for the next bull leg of the markets, it may just be the last one!