The Fed as a Fig Leaf

Everyone who has been wrong about the market has now joined in a familiar refrain:

The Fed is printing money. It is the only thing holding up stocks. It will all end badly.


A little research on these sources shows that – as of a few months ago – their take on the Fed included the following:

  • The Fed is irrelevant
  • The Fed is pushing on a string
  • The Fed is in a box
  • The effectiveness of QE has declined with each new round.

When the various bearish predictions have not played out, the same sources come up with a NEW VERSION of the theory. In this revised story, no one could possibly have predicted the effect of the Fed's money printing and debasement of the currency. Wow!

Once again this flies in the face of facts:

  1. While the Fed's balance sheet has increased, M2 growth has been modest. Whatever "printing" is taking place seems to be stalled at the level of excess reserves.
  2. The dollar has actually strengthened. In fact, there is no real correlation to Fed policy – despite the rhetoric.


But it is an easy explanation. Blaming the Fed is a fig leaf for bad analysis.


The Reality – An Alternative Hypothesis

There is a simple reason for higher stock prices: Better economic conditions and higher profits. Over the last three years the most important market worries have lessened.

Most people struggle to understand the "wall of worry" concept. Briefly put, it means that, at any given time, stock prices might be lower than one expected because of headline risks. These are plentiful at all times, fueled by ratings-seeking media and blogs. Trying to explain how Europe will bargain its way to a solution is pretty boring when compared to footage of a run on banks in Cyprus!

It is very difficult to evaluate the worries in real time. To avoid this problem, let us use the Wayback machine to go back three years. In my Dow 20K series, I raised a number of "what if" questions. The commenters were most of the "Miller, you idiot" persuasion. Feel free to go back and see how nearly everyone questioned the mere possibility that any problems might be solved. Here was the favorite from the Seeking Alpha crowd:

'What if unemployment falls to 8%? What if the annual budget deficit is reduced? What if earnings for US companies continue to surge, leaving the 10-year trailing earnings in the dust?'

And what if my aunt had balls?

She'd be my uncle!

The smart-aleck who offered this viewpoint is still around — providing the same "in-depth" and inaccurate analysis.

But let us turn to what I suggested…

My List of "What if's"

This is all from the article three years ago:

Asking the Right Questions

The bias is inherent in the situation. The problems are known. If you write for a major publication, you are rewarded for analyzing the negativity. If you go on TV, you are expected to parrot the analysis of problems. This makes you seem smart.

By contrast, the solutions are vague and unknown. If you even talk about them, all of the "hot shots" are skeptical.

That should be your clue to pay attention. Repeating the known news does not make you money. Try asking these questions:

  • What if unemployment falls to 8%?
  • What if the annual budget deficit is reduced?
  • What if housing prices and sales show a clear bottom?
  • What if mortgage rates remain low?
  • What if politicians negotiate a compromise on tax increases?
  • What if Europe stabilizes?
  • What if China and other emerging countries resume a solid growth path?
  • What if earnings for US companies continue to surge, leaving the 10-year trailing earnings in the dust?
  • What if the US rationalizes immigration?

If you have not thought about these possibilities, you have a fixation on negativity. My Dow 20K concept is designed to set you free — to get you thinking about the long sweep of history and the potential for success. If even a few of these things happen, what would be the market reaction?

If you look objectively at the list from years ago, you will see that most of the items have been accomplished and there has been significant progress on the rest. What has that been worth in market value? The actual growth in S&P earnings is about the same as the increase in stocks.

Note well: This is not a story about the Fed, although Fed policy helped with economic growth and mortgages.

Choosing the Right Pundit

There is a group of market "experts" who have been completely wrong on all of the items on the list above. They have been wrong about "headwinds", recession probabilities, and the overall market. They were also wrong about the Fed – both in forecasting policy and the ultimate effect. You can see them every day on financial TV and in the media. The quoted "Street Cred" does not mention the past results of their methods.

These pundits now desperately cling to their pseudo-expertise on "global macro." They seize the "fig leaf" of the Fed. It is easier to claim that you missed the power of the central banks to "print" than to admit that you had the whole story wrong.

They are now warning that a disaster looms. Please note that the new prediction rests upon the accuracy of the old one.

Investor Lesson

Those who have been wrong about Fed policy so far, will also be wrong about the exit. Take a deep breath. I am a consumer of economic information, and so are you. We succeed if we find the best sources. Right now that means understanding that it is not all about the Fed – despite the daily media diet of news.

The complete story will require more than one post, but I did show the way with the first installment. My next post will ask what the effect would be if the Fed unwound the entire balance sheet in one year. What is your guess? Let us suppose two methods:

  1. No notice at all.
  2. Announcement of the general plan, but without daily or weekly specifics.

We all know that it could not happen in either of these alternatives, but let us consider them as a useful hypothetical starting point.

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  • lou May 24, 2013
    The above link adds a bit of humor to the reality that cable bobbleheads don’t know and more importantly don’t care about facts or reality.

  • jd May 25, 2013  

    Very helpful, Jeff.
    And something that has rather significant investment implications looking ahead to the next 2-5 years.
    I hope you keep this theme alive in your writings at this stage of things.
    By, that I mean that we are, again, at a turning point in attitudes, where things might work out much better than all our fears suggest.

  • Aristotle May 26, 2013  

    Jeff, I’ve been reading your blog regularly. Congrats on geting a mention on Ritholz’s blog for “10 Sunday Reads”!

  • Mike Pitre June 3, 2013  

    Jeff I agree with you comments about investors should not try to be all in or all out of the market. But at the same time I have really never met anyone who did not try to time their investments in some way.

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