handoffs are messy.

Mohamed El-Erian uses the term “handoffs” to describe the changes taking place around the world as various market forces and regimes take over from each other.

In China, it’s the handoff between an infrastructure-based economy to a consumer-driven one, for example.

Here in the US, we’re attempting a handoff from a Federal Reserve life-support economy to one that can sustain and ultimately feed off of itself. This will take time, we are not ready and it will be messy. A lot of the messiness will involve the adjustments of expectations and assumptions. Expectations and assumptions are human constructs and as such they are wrapped in emotion. These emotions manifest themselves in price action around the world and across asset classes – stocks, bonds, currencies, commodities.

Today was a great example of this.

taper

Should rates get totally out of control, the Fed will come right back in and swamp the bond market with cash. Should stocks pick up more steam to the downside, Treasurys will get a bid out of fear and this will halt the fear over rising rates (because rates will come down as a result of the panic buying). To some extent then, this will be a self-correcting spiral in the end, even if it is an unpleasant one.

That’s all there is to it.

While it looks out of control, it is anything but. It is entirely logical that markets should behave this way in-between here and where we’re headed – which is a better economy that requires less Fed involvement…someday. The short-term pain will be justified by lesser government involvement and a return to fundamentally-driven capitalism in the long-run.

Grit your teeth.

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Good night.

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