There is a lesson that market history has clearly and repeatedly demonstrated, and that is that the Fed, depending upon its commitment and duration, does create excess. It creates excess pricing and trends that "would not otherwise be" has it not been for its manipulations of money.
By J. Mike Oliver
August 26, 2013
When and where were you…when you were jolted to reality by the clarity of the thoughts of Austrian-school economists and libertarians like Murray Rothbard?
I was in high school in the mid-1960s and the jolt propelled me through college and into graduate school in the early 1970s. It was as if I had attached myself to rockets. And indeed I had.
Like many back then, the trajectory was unquestionably toward academia – and a career in university teaching and furthering what we had learned from those minds. But alas, I deviated.
The mid-1970s depression delayed many academic careers as hiring at universities ground to a halt. In my case I jumped ship from a Ph.D. program at Univ. of Hawaii and went to E.F. Hutton (N.Y.C.) as a gold futures specialist – back when that market was “legalized by the authorities” in 1975. I was going to latch myself to that anti-statist commodity and it would be simple – the metal that would ultimately supplant the various fiat currencies with a dose of reality, and I was going to be at least one of its spokesmen on Wall Street. Little did I know at the time. I learned.
The ride from there to here was a long one, bumpy and full of ever increasing cycles of ups and downs, and not merely by gold. All asset categories have undergone boom-bust cycles over the past 30 and more years. And now those cycles are looking more and more like terminal heart-attack oscillations.
And despite being what I regard as very knowledgeable about libertarian concepts, free market theory, and so forth, I have learned some things that are somewhat “outside” of our mutually-shared view of markets, men and the State. I pass some observations along.
The capital raising and lending business (broker-dealers, banks, etc.) are to the popular culture what “capitalism” is or at least what they think it is. But in truth the financial/investment industry is fully split, as is the broader culture, between those who respect and understand the concepts of a free market and those who are quite frankly the lapdogs of the State, of the Fed and the ideology of the State. You can see a fair sampling of this intellectual division on CNBC – for example the difference between Rick Santelli on the one hand (who in his 2009 on-air rant, declared the need for a “tea party”) versus CNBC’s Fed analyst, Steve Leisman, who rarely ever does more than laud the actions of the Fed. This divide is not merely one of a marketing contrivance by CNBC, to offer a false “balance,” but is in my opinion a real divide in the financial arena – hedge funds, mutual funds, banks, brokers etc. – that actually buy and sell on Wall St. And these “players” are probably less-balanced in their view of the Fed than are the talking heads. The reason is that even those who presumably “know better” are in effect forced into the path set by the Fed. Such that investors and asset managers that are obediently following the Fed’s breadcrumb trail even include asset managers who often confess on financial TV that “all of this will end badly.” Yet they are forced to go with the tide and they do. And so, willy-nilly, the Fed-loving asset managers and the Fed-doubting asset managers alike are channeled into buying stocks (that’s the current stated Fed goal, somewhat different from prior boom bust cycles). And in so doing the blue chip U.S. stock indexes have outpaced on the upside all indexes worldwide, over the past two years in particular. An outpacing and out-pricing that has no historical comparison. For example just by referencing current S&P500 price level versus its highs in early 2011 (a point when most stock indexes suffered a sharp pullback) its action is more than 20% above that high, whereas most indexes globally remain below that high and only a few (FT-100 in London and DAX in Germany) are marginally out above that peak. In sum, the Fed has “succeeded” in its stated goal of driving stock prices up, with the ulterior motive of creating a “wealth effect” among U.S. investors. An openly declared effort to fake reality. In my professional assessment the current U.S. stock market is now clearly a phenomenon which can be defined and measured many ways – as a bubble of great excess. The axiom is “You can’t fight the Fed.”
The reason that asset managers “must” play the game is that the more fearless (mindless) among them have already committed themselves headlong into the Fed-led buying frenzy and have gained nicely in so doing. Generally this feeding commenced around the time of the QE2 announcement in August, 2010 – three years ago. Those who doubted or were reluctant in their commitment to Fed-chasing were marginalized in the constant peer assessment process that’s called “relative performance.” If you were not up-to-the-eyeballs-long stocks, especially U.S. stocks, then you were not being benefited by the Fed’s largesse, and you soon learned your lesson as your clients, one-by-one, peeled away to sign-up with the “better performers.” One herd then joined by another, and it persisted, and in so doing has further perpetuated the myth of the omnipotence of the Fed.
Another thing I have learned in the past 37 years, and have to some extent be able to measure with some precision, is the absolute and recurring failure of herd-like, trend-following behavior by those who act upon the Fed axiom. Meaning, to you Austrians and libertarians out there who think you have your concepts in order, you do. Please do not be doubtful of your intellectual foundation, nor dismayed by the ability of this Fed-led game to persist for so long and to create so many rewarded followers. And especially I say to the many young new students of Austrian-school economics and of libertarianism – you are only just now seeing probably your first major example of a boom-bust cycle. Do not doubt your concepts because of the “fact” that your young investing buddies are making money by acting upon “the Fed is invulnerable” axiom. It has happened before and is now happening again, though this time around it could very well be different in terms of the significance of the consequent bust. More on that in a minute.
There is a lesson that market history has clearly and repeatedly demonstrated, at least all the years I have been technically analyzing markets (and during which time I have kept my libertarian mode of assessment at arms-length from my proprietary technical measures). The lesson is that the Fed, depending upon its commitment and duration (and I should include Federal government policies in this process as well, such as the Clinton “single family home for everyone” policy) does create excess. And that’s the point. It does create excess pricing and trends that “would not otherwise be” had it not been for its manipulations of the unit of measure, the money unit – sometimes dramatic manipulations. These policies persist not because they are viable, but because they come from the barrel of the gun of the State. To some extent they are unavoidable. And like any coercive homogenizing policy they are believed in by many who follow in their wake. And in the early and middle phases of these booms those who do follow are rewarded. Therefore it is often the case that these policies will in fact generate “trends” that attract many, and which persist over sufficient periods of time to create the veneer of “sustainability.” The early doubters become late joiners, again because of the peer group “performance” pressures that come in the wake of such policy-driven trends.
Ask the “investor” who thought he had found a career in “flipping” homes in 2006 and 2007. He might have been a late-joiner, following some buddies who showed him the way, but he, like even some of the reluctant and more sober banks, finally joined-in the mortgage orgy (for the banks it was the bundled MBS orgy) of those years. And yes, they paid dearly for their belief structure – a wholesale discounting in price of their asset category. Yet that was just another massive market trap in a parade of such bubbles that have been sponsored by Fed action over the past handful of decades and longer. And, of course, it lasted just long enough to make it seem inevitable and sustainable. Those are the recurring attributes of this process – attributes which must be acknowledged and “respected.” Excess trend and the perception of sustainability of that trend. They are almost prerequisites for the great unwinding. Beware and respectful of the process that the Fed creates. Yes, it is a distortive and is a false process, but in its early and middle phase it “works”…up to a point. This lesson about market place reality is one that contains the alternative to the Fed axiom. That alternative axiom can be expressed in several ways, but I prefer “You can’t fool mother nature!” (meaning the markets). At least not forever. And if you think you have done so – if you have a sense of assuredness regarding your Fed-sponsored asset market – and if that cocky smile is now widely spread among other investors and asset managers, then in all likelihood the comeuppance is near.
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