This guest commentary was written on 9/17/20 by Mike O'Rourke, Chief Market Strategist at JonesTrading.
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“…I would say, if you look at the long experience of the 10-year, 8-month expansion, the longest in our recorded history, it included an awful lot of quantitative easing and low rates for seven years. And I would say it was notable for the lack of the emergence of some sort of a financial bubble, a housing bubble or some kind of a bubble, the popping of which could threaten the expansion. That didn’t happen. And frankly, it hasn’t really happened around the world since then.” - Jay Powell, September 16, 2020 |
To be fair to the Chairman, he did note that just because of the fact that a bubble has not materialized yet, it does not mean one won’t. That thinking obviously means the Fed Chairman does not believe we currently have asset bubbles.
For years we have expressed the view that the Federal Reserve has fueled asset bubbles in several asset classes. The Fed Chairman and his predecessors are in the enviable position of being able to print money to support asset prices, thus, since their bubbles have not popped, they don’t exist.
For now, markets have been placated by the – if we don’t acknowledge it, it does not exist - approach. That often works very late in a bull market, even if it has ended.
The Fed Chairman obviously missed this week’s edition of Barron’s in which the cover story literally read, “Yes, It’s a Stock Market Bubble. But That Doesn’t Mean Trouble Just Yet.” Barron’s is one the world’s most respected financial periodicals, with a century of history.
The reason Barron’s believe the bubble is not “trouble yet” is the Federal Reserve.
According to the story:
“Behind the scenes, meanwhile, the Fed is operating the bubble-making machinery. It has pumped trillions of dollars into the economy, expanding its own balance sheet to more than $7 trillion from $4.1 trillion at the start of 2020 … Fed Chairman Jerome Powell has effectively promised to keep rates low for years, which means there should be plenty of cash sloshing around to keep the bubble growing.”
The article's author, Ben Levisohn, is spot on in describing the Fed’s bubble making machinery. Where we differ is our opinion on the central bank's ability to sustain the bubble.
If you were buying stock in late March when equities were more than 30% lower and the Federal Reserve was buying more than one hundred billion dollars of assets a day, the risk – reward scale was tilted in your favor. That is in contrast to chasing the market at levels 60% higher now, with the Fed purchasing $120 Billion of assets per month.
With the recent summer highs being set by a combination of leveraged retail speculators in the options market along with a corporate speculator, it makes the situation that much more alarming. The nature of this summer’s buying (on account of stock splits) is among the most dangerous of all.
Splits do not create value and are more likely to break the momentum in those market leaders. We suspect it is this behavior that should mark the top of this bull market.
Investors need to remember these situations take time to play out. It was in March of 2007 when Chairman Bernanke asserted, “At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”
The Equity market peaked a little more than 6 months later, Lehman Brother’s failed 18 months later. Regardless of where the asset prices were in March 2007, the fundamental corrosion was well established. We expect Chairman Powell’s quote above to meet a similar, and likely worse, fate. Chairman Bernanke had the luxury of 5 years and 3 ½ quantitative easing programs to make himself right.
Powell has already spent $4 Trillion in a span of months. Right, there are no bubbles here Mr. Chairman, you keep telling yourself that.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor piece written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.
