July 2021
… even when it triumphs over experience
When the tech bubble burst around the turn of the century about 58% of Americans owned some stocks, and they took a horrific beating. So, the Federal Reserve Bank lowered the Fed Funds rate by about 5.4% from December of 2000 to December of 2003 which helped prices recover. Still, a 60/40 stock and bond portfolio was in drawdown and recovery for 4.3 years. The NASDAQ index was in drawdown and recovery for about 14 years.
Lowering rates to levels not seen in almost 50 years, the Fed also helped create the lowest mortgage rates most people had ever seen. Super-affordable mortgages meant real estate prices could get much higher, without needing a higher income to qualify. A real estate bubble was created, even before Wall Street put the entire thing on steroids and set the stage for the next financial crisis. When mortgage default rates moved higher it became evident that mortgage-backed securities and related credit default swaps were going to really hurt some sophisticated Wall Street bankers and their institutional customers, it was sold as a crisis that needed to be remedied by the (future) US taxpayers via intervention by the Federal Reserve. So, beginning in August 2007, the Fed Funds rate was once again lowered by about 5.5%. Additionally, the Fed embarked on a program of using public funds to buy up assets that the creators of this mess still owned but were not willing to sell at prices set by the markets. This was called “quantitative easing” probably because it sounded better than “bailout”. Still, a 60/40 stock and bond portfolio was in drawdown and recovery for about 3.3 years.
With the Fed Funds rate now at 0.25%, they won’t be able to lower it by 5.5% in response to the next wealth crisis experienced by owners of stocks. Accelerating rate increases beforehand might bring on the next market correction. Besides, current levels of federal and state debt would make debt servicing untenable at significantly higher rates.
Central banks exist to delay the consequences of excess and allow politicians to avoid addressing structural problems. Preventing these market forces from playing out at each sign of trouble, the can gets kicked further and further down the road. Each successive recovery keeps the illusion of solvency alive, but “accommodation” requires ever-lower rates to support the charade. In the meantime, debt keeps expanding, while each recovery produces less and less organically driven growth, and ever-higher wealth inequality.
Oscar Wilde is credited with having said “Marriage is the triumph of imagination over intelligence. Second marriage is the triumph of hope over experience.” Substitute “investing during a mania” for “marriage” in the quote above and you’ll understand what is going on in the stock market today.[1]
Thanks to engineered low interest rates, current exposure to the stock market is higher than ever and investors hope they won’t get burned. Perhaps hope stems from a belief that they are somehow, standing closer to the exit than other investors or will hear the alarm sooner. Maybe they hope that a quick stock market recovery will happen without the Fed lowering rates by 5.5%, and they can easily just ride out the next major correction. Maybe they hope that continued low rates and QE will ward off a major market correction for their entire investing horizon.
Hope is not a strategy.
[1] Thanks to Jesse Felder