“THE MARKET FORCES WILL OVERWHELM US”

A little truthiness from a Fed Gov and the always truthful John Hussman:

“The history is that monetary policy is not ultimately a very effective tool at solving real economic structural problems. It can try for a while but the problem then is that it’s only temporarily effective, and when you can’t do it anymore you get the explosion yesterday in the Swiss market. One of the things I’ve tried to argue is look, if we believe that monetary policy is doing what we say it’s doing and depressing real interest rates and goosing the economy, and we’re in some sense distorting what might be the normal market outcomes, at some point we’re going to have to stop doing it. At some point the pressure is going to be too great. The market forces are going to overwhelm us. We’re not going to be able to hold the line anymore. And then you get that rapid snapback in premiums as the market realizes that central banks can’t do this forever. And that’s going to cause volatility and disruption.” – Charles Plosser

For all the Fed chasing lemming investing geniuses who think the Fed keeping interest rates low guarantees investment riches, think again:

But – a Fed-chasing lemming might counter, in the belief that Federal Reserve intervention “works” regardless of investor risk preferences – if the economy softens, doesn’t that ensure that the Fed will come to the rescue by deferring any hike in interest rates? Won’t that in turn drive the financial markets higher?

There are two answers to that question. The first, as I noted in The Line Between Rational Speculation and Market Collapse, is a reminder that the Fed did not tighten in 1929, but instead began cutting interest rates on February 11, 1930 – nearly two and a half years before the market bottomed. The Fed cut rates on January 3, 2001 just as a two-year bear market collapse was starting, and kept cutting all the way down. The Fed cut the federal funds rate on September 18, 2007 – several weeks before the top of the market, and kept cutting all the way down.

With median valuations for the average stock higher now than in 2000 on the basis of price/revenue, price/earnings, and enterprise-value to EBITDA; with numerous historically reliable valuation measures more than double their pre-bubble historical norms; and with the S&P 500 now beyond the peak valuations of every market cycle on record (including 1929) except for the final quarters surrounding the 2000 bubble, understand that stocks are no longer an investment but a speculation.

As for the completion of the present cycle, I’ll say this again – the 2000-2002 decline wiped out the entire total return of the S&P 500, in excess of Treasury bill returns – all the way back to May 1996. The 2007-2009 decline wiped out the entire total return of the S&P 500, in excess of Treasury bills – all the way back to June 1995. A shift back toward risk-seeking preferences among investors will not relieve the extreme overvaluation of the equity market, but it would defer our immediate concerns. We may observe constructive opportunities along the way, but we view it as inescapable that the completion of the current market cycle will end in tears for investors who don’t carefully align their investment exposures with their expected spending horizon (see the second half of Hard Won Lessons and the Bird in the Hand for a discussion of these considerations). For now, we maintain a sharply negative outlook toward equities.

Read all of Hussman’s Weekly Letter