The Dow Jones Industrial Average made another concerted run at the elusive 27,000 milestone over the last several weeks. But, as of this writing, the index has stalled out short of this psychosomatic barrier. By our estimation, this is for the best.
While not always apparent, the stock market generally maintains a loose connection to the underlying economy. Over long multi-decade periods, as measured by the price-to-earnings (P/E) ratio, it will undulate between stages where it’s cheap and stages where it’s dear. Eventually, however, the stock market reverts towards its mean P/E ratio – always overshooting and undershooting as it cycles about.
One of the unintended consequences of fiscal and monetary intervention is that it distorts this relationship. Stimulus intended to juice the economy has the effect of juicing financial markets. Sometimes these inflationary policies have the effect of completely disconnecting the stock market from the economy.
For example, Venezuela’s Caracas Stock Exchange, Stock Market Index, has soared over 36,000 percent in the past year alone. Yet no one, save President Nicolás Maduro, would point to the booming Caracas Stock Exchange as an indication of a healthy and sound economy. In truth, the Caracas Stock Exchange is a barometer of the country’s insane economic policies.
Hence, after a decade long bull market in U.S. stocks, one that’s pushed the P/E ratio to nosebleed valuations, we find comfort and relief in a sideways or falling stock market. Perhaps the U.S. stock market is not entirely rigged after all. Perhaps it’s only partially rigged.
Still, we have some reservations…
Devising a System of Chaos
When Alan Greenspan first executed the “Greenspan put” following the 1987 Black Monday crash, financial markets were well positioned for this centrally coordinated intervention. Interest rates, after peaking out in 1981, were still high. The yield on the 10-Year Treasury note was about 9 percent. There was plenty of room for borrowing costs to fall.
The mechanics of the Greenspan put are extraordinarily simple. When the stock market drops by about 20 percent, the Fed intervenes by lowering the federal funds rate. This typically results in a real negative yield, and an abundance of cheap credit.
This tactic has a twofold effect of seen and observable market distortions. First, the burst of liquidity puts an elevated floor under how far the stock market falls. Thus, the put option effect. Second, the interest rate cuts inflate bond prices, as bond prices move inverse to interest rates.
As of the late 1980s, thanks to the Greenspan put, the Fed has been running an implicit program of countercyclical stock market monetary stimulus. Ben Bernanke then ratcheted up the Fed’s extreme intervention into financial markets via quantitative easing in the aftermath of the 2008-09 financial crisis. That’s when things really got nuts.
If you recall, QE involves creating money from nothing and loaning it to the Treasury. It also has involved bailing out the big banks by swapping fake money for toxic mortgage backed securities. During the next stock market crash, QE will likely involve conjuring fake money into existence and plowing it into the S&P 500 or into shares of government preferred companies.
As you can see, U.S. financial markets have been rigged for at least three decades. But what do you expect in a fake money system where the expedient takes priority? One expedient after another, year after year, decade after decade, has devised a system of chaos.
Fed Chair Powell’s Plan to Pickle the Economy
Bernanke, and later Yellen, said these unconventional QE policies were temporary. That the Fed’s massive balance sheet expansion would later be normalized. Similarly, when Nixon suspended convertibility of the dollar into gold on August 15, 1971, he said it was temporary.
But once a cucumber becomes a pickle it can never be a cucumber again. Indeed, financial markets have been pickled over to no end. What’s more, Fed Chair Powell’s efforts to unpickle QE were met with howls from the President, Wall Street, and Larry Kudlow.
These howls still continue even as Powell’s reversed course and declared that unconventional policies are now the new normal. Just this week, in reference to the Fed, Trump tweeted the following assessment: “They don’t have a clue!”
Meanwhile, Powell, a man of expedience, is mixing up a new batch of brine to further pickle financial markets…
A capital investment dearth? Add more cider vinegar.
Retail earnings slump? Mix in more salt.
No doubt, the central planners have taken us to this place of absurdity. And when the economy cracks, and GDP dumps, and the stock market slumps, Powell, with Trump egging him on, will bathe financial markets in brine. Remember, this is the expedient thing to do.
The ultimate result, however, is that it will pickle U.S. financial, economic, and social systems all the way over to Venezuela. By all honest accounts, we’re doomed.
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