Bull markets are born of despair and capitulation; they die on the best of times when the majority of the population has reached full employment and most are celebrating their good fortune. Well, that had been the history for the greater part of the past century. But since the year 2000 and the most painful events of September 11, the Federal Reserve has been in a quest to sustain the funding of the federal government's various war campaigns and entitlement programs through the money printing press, otherwise known as its Quantitative Easing program, which started in earnest in 2008. Through both weak and strong performance of the nation's economy, the Fed has been consistent in that regard. At no time in the past 20 years did the elected officials of the federal government truly balance the budget, and the Fed fail to be supportive of deficit spending.
The Federal government has grown much larger and expanded its reach within the economy to such a degree since 2001 that now because of pandemic assistance (the 2.2 Trillion dollar CARES Act - $600 per week added benefit to the unemployed), small private employers have had to compete with the federal government for labor. But this past weekend with the ending of the pandemic assistance came a new chance for small businesses to hire back staff that otherwise might have already rejoined the workforce. And so, it appears that we shall see a higher labor force participation rate and a lower unemployment rate in the near future, both highly desirable.
With the pandemic support winding down by the Congress through the elimination of the 600 dollar a week addition to state unemployment insurance, the federal deficit will be reduced markedly. That being the case, it will give the Federal Reserve some flexibility in its options when it finally makes the much anticipated move to lessen support to the credit markets by tapering its 120 billion dollar a month QE program. But here's the rub as they say, the last time the Fed started to curtail its support in 2013 the markets reacted badly. When then Fed chairman, Ben Bernanke, indicated an intention to slow the pace of QE, 10-Year treasuries jumped from a yield of 1.7% to 3% and stock markets had a short-term panicky move down in response. The event was dubbed the “Taper Tantrum”. A much chastened Fed backed off its intended path and continued its program of buying treasuries and mortgage backed securities at the prior levels, calming the markets.
So whither the Fed now? If this is the last inning of support for the credit and asset markets, what can we as traders and investors anticipate? Since the pandemic panic lows of March 2020, stock markets have doubled, and residential real estate has increased by more than 20%. Valuations are stretched, but earnings have been what some have termed “spectacular” or even “stellar”. The Fed has accomplished its goal. Continuation of the $120 billion QE program as it is now risks more than just transitory inflation. During the late 1960’s the Fed acted with similar patriotic regard for the federal government spending during the Vietnam War. It kept interest rates well below the rate of inflation for far too long. The economy suffered through stagnation, shortages of consumer goods, bottlenecks, union strikes, and a stock market that declined. We may be in such a period now, the 10-year Treasury note is around 1.3% and inflation is running at 5.4%. That is a whopping difference.
Keep one eye on GDP, inflation statistics, and the job numbers. And the other eye on interest rate movements and the Fed. If rates backup like 2013 we may have a nasty stock market.
Be wary, and stay safe.
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