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Trader Eric Schumacher works on the floor of the New York Stock Exchange, in New York. (Richard Drew/AP)
Trader Eric Schumacher works on the floor of the New York Stock Exchange, in New York. (Richard Drew/AP)

Can stocks stay afloat without the Fed? Add to ...

Caroline Baum at Bloomberg News makes a very good point about the reaction to the Federal Reserve’s discussion last month about the costs of economic stimulus – revealed on Wednesday with the release of the meeting’s minutes, which skewered stocks.

“Market participants forget that the Fed is neither omniscient nor a very good forecaster. What it is is the sole proprietor of the printing press. If the hint of cutting back on its hours of operation is enough to frighten the stock market, then the Fed really has to be concerned by what it hath wrought,” Ms. Baum said in a column.

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The point here is that stimulus-obsessed Fed policy has driven investors to take risks – specifically, driving investors out of cash and into stocks – but that risk-taking can be unwound very quickly at the first sign of shifting policy.

The minutes from the Fed’s monetary policy meeting in January reveal that some members are wavering in their commitment to buy $85-billion (U.S.) worth of assets each month because the cost (potential financial instability) could outweigh the benefits (low borrowing costs, economic growth). That has investors wondering what comes next.

As Tim Duy, an economics professor at the University of Oregan, remarked on his blog, “If the Fed is already wavering on the pace of quantitative easing, can it be long before they waver on their commitment to low rates as well?”

Without Fed stimulus, investors seem to lack much faith in the stock market. The S&P 500 was hit by its biggest one-day selloff of the year on Wednesday. It fell again on Thursday, dragging it below 1500 in afternoon trading – or down nearly 2.2 per cent over the past two days.

Areas of the market with greater exposure to the economy have been hit considerably harder than more defensive areas, suggesting little appetite for riskier stocks in particular.

Financials, consumer discretionary stocks, tech stocks and commodity producers have fallen by 2.5 per cent or more. On the other hand, defensive consumer staples have actually risen over the past two days, though by a scant 0.1 per cent. Similarly, telecom stocks have fallen just 0.1 per cent and utilities are down 0.7 per cent.

To be sure, stocks are wrestling with far more than just Fed policy. As I pointed out earlier, lofty valuations, a stunning seven-week winning streak for stocks and uncertainty about U.S. budget cuts have made some sort of stock market pullback all-but-inevitable.

But with riskier areas of the market taking the brunt of the selloff, the Fed has given investors something to think about: Without the Fed, do stocks have a chance?

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