The Economy's heading in the right direction.......Don't Panic! Don't Panic!

"Don't Panic! Don't Panic!"

             The famous phrase often heard shouted by Lance-Corporal Jones in the 70's comedy Dad's Army. For those of you not familiar with the show, it was set in an English village in World War Two showing the events encompassing the home guard for that town. In most episodes some minor disaster begins to unfold and Jones runs around trying to keep everyone else calm by panicking himself and screaming "Don't Panic! Don't Panic!" This is kind of what I feel is happening in the markets at the moment. The major difference being that the equity markets are actually panicking at the suggestion of an improving economy!

          Yesterday, Federal Reserve chairman Ben Bernanke spoke about how the Fed was potentially going to look to reduce QE in the coming months, potentially ending it completely in mid-2014. The reaction of the markets......all 3 major stock market indices in the US (S&P500, Dow Jones & Nasdaq) dropped between 1.1-1.39%. The main Asian markets slid over 1.5% on average this morning, whilst European markets are on the whole currently down over 2% as I write this. This reaction was inevitable, as I mentioned in my previous blog, because, to put it using the same analogy, the kid feels that he's going to fall of his bike just because the parent has suggested they might remove their hands from the handlebars. Lance-Corporal Jones is running up and down the S&P500 and global markets screaming don't panic and hitting the sell button!

     But should we be panicking? After all the Fed is potentially going to reduce some of the stimulus into the economy, how will it survive without it. Well firstly markets really need to think a bit more rationally and calmly about what Bernanke actually said.

Bernanke posted predictions for 2014 of US GDP growth (the main indicator for the economy) between 3-3.5%, US unemployment falling to between 6.5-6.8% (it's currently at 7.6%) and inflation being close to the long term Fed target of 2% at between 1.4-2% (it's currently at approximately 0.7%). Bernanke then said:

“If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it would be appropriate to moderate the pace of purchases later this year, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year." 

However he then went on to say:

“If you draw the conclusion that I just said that our policies -- that our purchases will end in the middle of next year, you’ve drawn the wrong conclusion, because our purchases are tied to what happens in the economy, If the economy does not improve along the lines that we expect, we will provide additional support.”

       So to be clear, if the Fed believes that the key economic indicators mentioned above roughly become inline with what they've forecasted, then due to the improved economic performance they can begin to reduce the amount of QE (bond purchases) being used each month. The hope being that by the middle of 2014 they will no longer need to be pumping extra money into the market through asset purchases. The second part of the statement more importantly says that they are not definitively going to end QE by that point, and for the market not to draw that conclusion because, in his own words "If the economy does not improve along the lines that we expect, we will provide additional support".

        In my view, the market should be embracing what the Fed has come out and declared. It should be a reason to be optimistic about the future, with indicators showing that the US economy is improving, albeit slowly for now, but on an upward trend. What Bernanke has come out and said is that the Fed believes the economy will improve significantly in 2014, and if it does so, there is not the need to keep the hands on the handlebars. If inflation is able to remain stable close to the 2% target on it's own and unemployment is at a more acceptable level, with GDP growth pointing towards a potential for further reduction in that unemployment number, then there is no need for that stimulus to be continuously provided. They would view the economy as being in a position to stimulate itself into gaining further momentum and surviving on its own. If we go back to the bikes, if the parent sees that the kid can ride the bike, then holding the handlebars still will only hold the kid back. Let's let go of those handle bars gradually and see if the kid can pedal themselves and stay upright. We can always grab the bars again.

        If we're not seeing the progress as we want to see then the Fed is going to continue to go with QE. But even if it ends QE, it has not indicated that it is actually going to start reducing the money supply, it has indicated that it is just not going to continue to increase it every month through QE. The next obvious step is that it will begin to increase interest rates, and perhaps this is what the market is concerned at. But there's been no clear indication that the Fed has even broached this.

     The market should stop predicting the worst, when this hasn't even been indicated, and concentrate on what the figures are telling us, and more importantly what Bernanke has actually said and what this means. To quote from The Shawshank Redemption, one of my favorite films, we have a choice, "to get busy living or get busy dying".(Spoiler.....don't watch the link if you haven't seen the film!!) Things are still tough out there, but it's time to "get busy living" and look towards the positive indicators that things are looking up and stop panicking at what might go wrong.

Don't Panic! Don't Panic! Or in the words of the motivational posters from Britain in the second world war, Keep Calm and Carry On!