Is the Fed trying to wean the markets off monetary policy? Such was an interesting premise from To wit:
That is a powerful assessment. If true, there is an overarching impact on the economic and financial markets over the next decade. Such is critical when considering the impact on financial market returns over the previous decade.
Average Annual Returns By Period
We can trace those outsized returns back to the Fed’s and the Government’s fiscal policy interventions during that period. Following the financial crisis, the Federal Reserve intervened when the market stumbled or threatened the
Fed Balance Sheet vs SP500
Many suggest the Federal Reserve’s monetary interventions do not affect financial markets. However, the correlation between the two is extremely high.
Cumulative Growth Fed Balance Sheet vs SP500 Correlation
The result of more than a decade of unbridled monetary experiments led to a massive wealth gap in the U.S. Such has become front and center of the political landscape.
Real Household Networth vs GDP
It isn’t just the massive expansion in household net worth since the Financial Crisis that is troublesome. The problem is nearly 70% of that household net worth became concentrated in the top 10% of income earners.
Breakdown of Household Net Worth by Decile
It likely was not the Fed’s intention to cause such a massive redistribution of wealth. However, it was the result of its grand monetary experiment.
Pavlov’s Great Experiment
Classical conditioning refers to a learning procedure in which a potent stimulus food) becomes paired with a previously neutral stimulus (e.g.,. Pavlov discovered that when he introduced the neutral stimulus, the dogs would begin to salivate in anticipation of the potent stimulus, even though it was not currently present. This learning process results from the psychological of the stimuli.
This conditioning is what happened to investors over the last decade.
In 2010, then Fed Chairman Ben Bernanke introduced the to the financial markets by adding a to the Fed’s responsibilities – the creation of the
Importantly, for conditioning to work, thewhen introduced, must get followed by the for the to complete. For investors, as the Fed introduced each round of the the stock market rose, the
Evidence Of Successful Pairing
Twelve years and 400% gains later, the was complete. Such is why investors now move from one economic report and Fed meeting to the next in anticipation of the
The problem, as noted above, is that despite the massive expansion of the Fed’s balance sheet and the surge in asset prices, there was relatively little translation into broader economic prosperity.
The problem is the of monetary policy collapsed following the financial crisis.
Instead of the liquidity flowing through the system, it remained bottled up within institutions, and the ultra-wealthy, who had “However, those programs failed to boost the bottom 90% of Americans living paycheck-to-paycheck.
The failure of the flush of liquidity to translate into economic growth can be seen in the chart below. While the stock market returned more than 180% since the 2007 peak, that increase in asset prices was more than 6x the growth in real GDP and 2.3x the growth in corporate revenue.
Pull Forward Consumption Borrow From The Future
Since asset prices should reflect economic and revenue growth, the deviation is evidence of a more systemic problem. Of course, the problem comes when they try to reverse the process.
The Great Unwinding
The chart below sums up the magnitude of the Fed’s current problem.
Government Interventions vs Economic Growth
From bailing out Bear Stearns to HAMP, HARP, TARP, and a myriad of other Governmental bailouts, along with zero interest rates and a massive expansion of the Fed’s balance sheet, there was roughly $10 of monetary interventions for each $1 of economic growth.
Now, the Federal Reserve must figure out how to wean markets off of and return to organic growth. The consequence of the retraction of support should be obvious, as noted by Crooke.
Logically, the end of Pavlov’s great can not end for the better. Once the paired stimulus gets removed from the market, forward returns must return to the basic math of economic growth plus inflation and dividends. Such was the basic math of returns from 1900 to 2008.
In a world where the Fed wants 2% inflation, economic growth should equate to 2%, and we can assume dividends remain at 2%. That math is simple:
Such is a far cry below the 12% returns generated over the last 12 years. But such will be the consequence of weaning the markets off years of monetary madness.
Of course, there is a positive outcome to this as well.
The bottom line is that fixing the problem won’t be pain-free. Of course, breaking an addiction to any substance never is. The hope is that the withdrawal doesn’t kill the patient.