Large macro themes are driving market activity in 2019 – all of which have the potential to ca...
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Market Plunge Protection? Sorry to Burst Everyone's Bubble
10/04/2018 4:22 pm EST
Recently, I read an article which stated that quantitative tightening is the “death knell” to the stock market. Can this be true, asks Avi Gilburt Wednesday.
So, allow me to show you why this is just another market fallacy which has been propagated by market analysts and the general media, and then regurgitated from one investor to another until it has risen to the point of fact. However, at the end of the day, this too is simply not true.
While I am sure it would seem logical to most people that if the Fed takes money out of the system that the stock market would certainly drop. This premise is based upon the common belief that the cause of the market rally was the Fed’s quantitative easing process. So, if you remove the cause of the rally, then obviously the rally will reverse.
But, is that what has happened? And, if not, shouldn’t we then question whether the Fed was the true cause of the rally to begin with? Let’s look at some of the facts.
In January of 2014, the Fed began to taper is QE process. So, the common expectation was that the market would suffer. Well, the market was at 1800 when the Fed began to taper, and then rallied to a high a little over 2100 (a 17% rally). It sure does not seem as though the market suffered from tapering. So, let’s look further.
In October 2015, the Fed fully halted QE. And, as I am sure many of you remember, everyone was expecting a market crash.
Well, the market was around 1900 at the start of October and then rallied to 2100 in that same month. Yes, you heard me right. What many were certainly expecting to be a majorly negative impact upon the stock market turned into a 200 point (11% rally) in one month upon the halting of QE. It sure does not seem as though the market suffered from the cessation of QE.
Let’s now look at October 2017 when the Fed began to tighten its monetary policy. At the time, the market was at (SPX) 2500. Today, we stand at 2900, which means the stock market added another 16% from the day the Fed began to tighten. It sure does not seem as though the market has suffered from quantitative tightening either.
When the Fed began to change course on its quantitative easing process, almost any market participant and analyst you spoke with expected it to have a dramatically negative impact upon the stock market. I mean, since it is clear to everyone that the market rallied due to the Fed, then it was equally clear that the market would now react in the opposite manner when the Fed began reversing course.
However, the fact is that the stock market has gained 1100 points, which is a 61% rally, from the point at which the Fed began to change course. Yes, you heard me right.
So, I will ask you again: Do you think everyone’s expectations about the Fed’s reversal of course causing a similar impact upon the stock market was correct? And, if not, shouldn’t we then question whether the Fed is really controlling the stock market and was the true cause of the rally to begin with?
Sometimes you have to take a step back and question the common thinking of market participants. And, when you pull back that curtain it may come as a surprise as to what you may find.
There are many fallacies floating around regarding what drives the stock market. When you are able to cut through the fallacies you can then have a better chance at successfully managing your investment portfolio and risks based upon the realities of the market rather than the fallacies.
The reason I think this to be important is that almost all market participants view the Fed as almost omnipotent when it comes to the perceived effect is has on the stock market.
And, once this bull market completes in the mid-2020s as the market approaches and potentially even exceeds the 3500 SPX region, we may be entering a 10-20 year bear market as I see it right now. During that time, everyone will be quite certain that the Fed can come to the rescue. However, we seem to have forgotten our history, which will likely lead to mass disappointment and substantial losses when the Fed will be unable to stem the tide.
Oh, yes, I know. This time is different, as the Fed really does control the markets now and they know how to avoid market crashes.
But, as George Santayana wisely said, “those who do not remember the past are condemned to repeat it.”
For those that know their stock market history, you would know that those “in the know” were absolutely certain about the impossibility of a market crash right before the market crashed and lead us into the Great Depression. Let me show you a few examples:
“We will not have any more crashes in our time.”
This was said John Maynard Keynes in 1927, two years before the stock market crash which led to the Great Depression.
“I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future.”
- E. H. H. Simmons, President, New York Stock Exchange, January 12, 1928
“There will be no interruption of our permanent prosperity.”
- Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928
Have any of you heard of the Pierce Arrow Motor Car Company? You have not? Well, that is because they went bankrupt during the Great Depression. But, I digress.
“Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50-point or 60-point break from present levels, such as they have predicted. I expect to see the stock market a good deal higher within a few months.”
-This was said on October 17, 1929, a few weeks before the Great Crash, by Dr. Irving Fisher, professor of economics at Yale University. Dr. Fisher was one of the leading U.S. economists of his time. He, too, was certain of the Fed’s ability to engineer and manage the economy and the markets.
Yet, only three years later, he would write: “The Federal Reserve System, from February to December 1931, increased the issue of Federal Reserve notes by 80%. These issues were due to bank failures which made necessary a larger use of cash. Yet, after a wave of bank failures . . . both banks and their depositors began raiding each other in a cut-throat competition which more than defeated the new issues of Federal Reserve notes.” Irving Fisher, Booms and Depressions, 1932
But, yes, I am sure you are all right and that this time will be different. The Fed has learned so much since the Great Depression, and now really knows what to do. I mean, are they not the reason we have been rallying since 2009? Well, based upon my analysis above, maybe it’s time you recognize that correlation is not the same as causation.
And, if you still believe in the omnipotence of the Fed to control our markets, you may want to read an old article I wrote regarding the ability of the Fed and the Plunge Protection Team to prevent crashes based upon the realities of history:
Sorry to burst everyone’s bubble.
Avi Gilburt is a widely followed Elliott Wave technical analyst and founder of ElliottWaveTrader.net, a live Trading Room featuring his intraday market analysis (including emini S&P 500, metals, oil, USD & VXX), interactive member-analyst forum, and detailed library of Elliott Wave education.
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