Bill Miller, Chief Investment Officer
Today, Ben Bernanke, current Chairman of the Federal Reserve, is expected to announce a decision on whether to taper or not to taper. There are good arguments to taper, namely good employment growth and a budget deal between the Republicans and the Democrats. Likewise, there are good arguments to not taper, including low inflation and the possibility of higher interest rates. A key consideration for the Fed, should they decide to taper, will be interest rates. More specifically, the Fed does not want long-term interest rates to increase suddenly. We estimate that a sharp 1% increase in the long-term Treasury bond could cause as much as a 10% correction in the stock market.
Yesterday morning (December 17), ISI Group reported that the Fed will likely announce that there will be $400 billion left to buy in their Quantitative Easing program. This strikes us as a clever compromise between the taper or not to taper decision. Most importantly, it is not sudden. Both the stock and bond markets will have time, probably five months or more, to measure the impact of tapering. Thus, we hope to stay long stocks for normal seasonal strength in the first quarter of the new year. On the other hand, if the Fed announces a more sudden tapering exit, adding shorts to hedge stock market risk is a likely approach.