Fed 8217 s emerging markets dilemma amp January history

When equities fell in January, high risk events usually followed. Here’s a look at equities, using the Dow Jones Industrials index.

2010 – The last time stocks fell in January (-3.5% due to Volcker PropTrading speech) —Eurozone crisis kicked off and the May Flash Crash hit partly due to (GS DoJ investigation).

2000 – The bust of the technology bubble was kicked off by a 7% decline in January.

1998 – Another year of spectacular losses when the Asian currency crises coincided with damage in Russia and Brazil, a classic case of emerging markets collapse.

1990 – The year of the US Savings & Loans crisis and Saddam Hussein’s invasion of Kuwait started off with a 6% January fall before leading to a 17% decline in Aug-Nov.

January declines & high-risk events

- Unlike the popular “January Effect” analysis, which postulates that a decline in January implies a negative year, this analysis does not necessarily infer a decline in the full year, but instead implies 1 or 2 months of sharp declines. Thus, 2014 is likely to deliver the much-awaited decline of at least 10% from peak to trough in US equity indices.
- 2005 had a negative January for the Dow (-2.7%) with 6 losing months out of 12. No “high-risk” event occurred. It was the last year when the Dow & SP500 moved in opposite ways.
- Both 2008 and 2009 were negative for the Dow in January (-4.6% and -8.8% respectively)

Fed ought to go for minimal taper

Bernanke’s final FOMC meeting draws parallels with Greenspan’s final FOMC meeting in January 2006 when the Fed was in the midst of a (normalization) tightening campaign.

2006 was relatively benign for equities, with the exception of May when stocks plunged 5% and gold fell 6% in May & June on fears of excessive tightening. Today, the Fed is in early stages of normalizing policy via tapering its monthly asset purchases.

By delaying a tapering due to the EM sell-off, will the Fed refer to the excuse of “tightening credit markets” as it did last September when bond yields rose 55% in the preceding 4 months? Yields may be well below 3.0%, but it could take little to prop them back up to 3%, depending on the wording/actions of the FOMC. A taper on Wednesday will have to be accompanied by very dovish wording on rates remaining low due to downside risks to inflation. Yet, recent data argues otherwise– especially that the advanced Q4 GDP figures (due Thursday) will be propped by strong retail sales and big boost by falling international trade gap.

The Fed ought to take the risk by modestly tapering $5 bn ($5 bn in treasuries and no tapering in MBS).

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