1987 Redux Or Sweet Serenity

Tyler Durden's picture

The last time the S&P 500 rallied in such a serene manner as the current trend was March 1987 - a few months before monetary imbalances came undone and crashed in October 1987. Further, JPMorgan's Michael Cembalest notes that prior to WWII, the previous rally as calm and uninterrupted as this was in November 1928 - a year before the crash. The JPM CIO points out how the Fed's ZIRP has created a 'Portfolio Rebalancing Channel' (PRC) transmission mechanism from cheap credit to wealth effect through spending and profits (that has worked as planned) but the last leg on this mechanism has not functioned so well. Payroll growth has been underwhelming and the housing market remains stunted - leaving the real economy remaining fragile despite the market's appearance. The Fed remains committed to driving this 'channel' but, as Cembalest points out this could easily be derailed by inflation, a bond market revolt towards funding our 'Ecuadorean' deficits, or the pending fiscal cliff legislated for 2013. "So the PRC keeps chugging along, until the Fed's job is done (and Goldilocks continues), or something breaks."

The S&P 500 has gone up in almost a straight line since November 25th, propelled by unlimited ECB lending and some positive US economic surprises. I looked for other periods when the S&P went up like this, with almost no volatility (defined as a rally whose stats match/beat those in the chart).

In the post-war era, there were none. The last time this kind of rally happened: April 1943, after Germany was first defeated at Stalingrad. History does not rhyme; ninety years ago, money-printing led to calamity in Germany, and eventually, to disaster in Europe. Today, money-printing is designed to save it. Its impact led Mario Monti to declare this week that the European debt crisis was “almost over”.


In the US, the rally has been sustained by the view that Fed policy is working. A zero-cost-of-money is supposed to create a “Portfolio Rebalancing Channel (PRC)”. As shown in the charts below, the channel is now playing out presumably as the Fed expected after lowering the cost of money to zero in 2008:

  1. A flood of money goes into credit funds, lowering the cost of credit and more importantly, increasing its availability
  2. Rising credit and equity markets create a positive wealth effect
  3. The wealth effect leads to a rebound in spending, driven by the top 10% who account for ~30% of discretionary spending
  4. Industrial production picks up, leading to…
  5. A sharp rebound in S&P profits…
  6. And a similar rebound in capital spending…
  7. Eventually, accumulated profits and demand for goods and services leads to a rebound in payrolls…
  8. And eventually, home prices, although this cycle is clearly quite different given the supply overhang


But, it hasn’t worked perfectly, of course. Payroll growth is still too low, home prices haven’t rebounded, and trend growth is less than 3%.


The Fed committed again this week to keeping its zero cost of money policy in place until the recovery is on stronger footing. Fiscal policy needs to be easy as well, so that it does not get in the way. What could derail this one-way rally? Inflation, or a bond market revolt. Core inflation has risen close to its pre-crisis average but shows no signs of accelerating, and wage growth is weak. On fiscal policy and the Federal debt, a combination of the Fed (which bought 66% of net Treasury issuance last year), non-US central banks and US banks appear ready to finance America’s Ecuadorean deficits. Will the massive fiscal tightening legislated for 2013 happen if it can be postponed? There are bipartisan proposals, but the prospects appear dim. So, the PRC keeps chugging along, until the Fed’s job is done, or something breaks.

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Christoph830's picture

On the flip side:  "What could sustain this rally?" 


Net net its bullish in my opinion

J 457's picture

How so?  Would equities not immediately sell-off and WTI shoot to $150-$200 dpb?  Consumers would be paying $7-8.00 per gallon and most discretionary spending would significantly decrease.  Yes, some companies would profit from the war effort, but I would think more would suffer than benefit.

Christoph830's picture

Well I think WTI is going to shoot upwards regardless of whether or not we have a war with Iran simply due to neverending QE.  Although I agree with you that there'll be a short-term pullback in equities, I think in the medium to long term, the U.S. stock market would benefit.  One of the biggest inhibitors of economic growth right now (other than the Fed) is political gridlock.  A war would likely unite the country and give Obama the political cover to unveil a massive alternative energy platform in his second term, which, in theory, should create millions of new jobs.  I am not saying these jobs will be sustainable but I believe this is their line of thinking.

Spastica Rex's picture

Where would the money come from to pay for a "massive alternative energy platform?"

Oh, never mind.

J 457's picture

After years of never-ending wars I don't think the US people will unite over an Iran conflict.  Secondly, I don't think (most not all) people are foolish enough to fall for the "we need TARP and bail-out the banks and autos" story again.  Most people I talk to now say "screw them, let them fail next time."  Next time oil gets to $150 the peoples will start looking not only for big oil scapegoats but also commodity futures trader that bid up the price to make profit off of fixed incme granny.

RussellChester8's picture

my friend's sister makes $74/hr on the computer. She has been out of a job for seven months but last month her check was $17871 just working on the computer for a few hours. Read more on this site .... http://bit.ly/wYpMrv

Sans-culottes's picture

Inflation is good, right? Bernanke knows what he is doing like the cast of Jersey Whore...warming my bonfire with US Dollars

Schmuck Raker's picture


Only two Italian banks' shares have been halted today.

Banco Popolare



10:49 AM More 2011 vibes: Italian lender UniCredit hits limit down (-5.7%) and is halted from trading.

- seekingalpha.com


OOPS - missed one:

Intesa Sanpaolo (ISP IM) shares suspended limit down



ECB Whack-A-Kitty - YouTube 2min
pods's picture

I would have figured that by now Unicredit would have breached that all important level of 0?


DormRoom's picture

'transmission mechanism'?  That was before the consolidation of the banking sector into 5 monolithic TBTF, controlling 52% of the nation's assets [1].


The TBTF have become a transmission bottleneck, not a transmission mechanism.  And that's before discussing the rise of the hedge fund industry.


[1] http://cdn.the2012scenario.com/wp-content/uploads/2012/03/chart.jpg

ekm's picture

Hey Tylers

You've got to give me credit for mentioning 1987 first on ZH. Though, Charles Biderman gave me the idea.

Member OLDMAN knows something about it, also, since I'm not that old. I was 15 in 1987 chasing girls on the beach and playing soccer on the mediterranean.

alexwest's picture

#The S&P 500 has gone up in almost a straight line since November 25th,

amazing lack of trading memory..
during 2004-2007 yyy SPX did not have 5% corr at all..


Dr. Engali's picture

Yes it did. It had 3 corrections of 5% or more. Not a lot to be sure but they are still there.

bugs_'s picture

In the '87 crash there was some unusual behavior in the producer price index that suggested some sort of credit squeeze was happening in the background.  in hindsight(LOL) we also realized the odd-lot short sales had dropped to zero before the crash.

in further hindsight - with the lehman/bear/2008 experiences to draw from - revisiting "the feel" of the october 1987 event - it sure feels like the failure of a large institution is what truely precipitated it.  EF Hutton comes to mind.

AN0NYM0US's picture



of course that EF Hutton Ad if shown today would result in a DHS investigation

Village Smithy's picture

The problem with this strayegy is A) it is not working, and B) it is transfering wealth at the rate of billions per day to the top while at the same time moving billions in debt down. That's a pretty good recipe for disasterous social unrest.

SMG's picture

Will the peasant's unrest be enough to break the Drug/TV/IPhone/SNAP slave shackles?   Time will tell.

Village Smithy's picture

Yes time will tell. All nations have at their peripheries people who don't want to succeed and don't succeed. They are of course the first to suffer when things go badly. We are past that now and good people who have worked hard are starting to suffer. They want a better life for themselves and their children and I don't think they will tolerate this kleptocracy forever.

walküre's picture

Yes, when private sector jobs pay significantly less than the public sector.

Government is the biggest consumer, the biggest employer and biggest debtor.

Sustained by a freak show of banksters and polticians who only understand one keyboard command: Ctrl+P

The mirage of an economy cannot continue indefinitely.

5880's picture


my youth. thanks for the flashback!

KandiRaverHipster's picture

correction PRC=people's republic of china.  no pun intended?

mess nonster's picture

So, the PRC keeps chugging along, until the Fed’s job is done, or something breaks...

(with apologies to Robbie Burns)

"Cap'n Berrrrnanke sir, the ZIRP drive is starrtin' t' overrrheat!"

"Dammit, Timmy, we've got to outrun 'em! We're still within range of their derivative-blasters! Can you give me ANY more power?

"Cap'n! I'm givin' ye ale I've got! ...weeel, I CAN tweak the rehypothecation units, but... but it's verrrr denzhrous, Cap'n!"

Dammit, Timbo! Do it!

"Aye, sar! Shite, that's hot!"



slewie the pi-rat's picture

PRC of America, BiCheZ!

pretty good piece, mrD!  L0L!  keep drinking, tyler!

and i well remember the day;  somehow, things back then now seem less... radioactive...

they fixed it pretty fast, too, simply by following these two eZ steps:

  1. declare it a liquidity crisis
  2. flood the "markets" with hither-to unheard-of liquididididiocy

they fuking fixed, it too, BiCheZ!   just ask them!

Stock Tips Investment's picture

Congratulations on the article. It describes very clearly the intentions of the Fed. And like it or not, so far is working. What is the danger? As this is an economic program"artificial", the dangers are everywhere. For now, the main danger is Europe and its debt problem. Therefore, the recent intervention by Bernanke urging Europe to prevent any financial crisis in some of its members (eg Spain). The second biggest danger is theU.S. government deficit. If the government does not implement a serious program ofdeficit reduction, the plan may "exploit them in the face." Finlmente, the danger is the market. If the market believes that this plan does not work, stock prices will fall and all the construction of the Fed will fall like an old building.(www.stocktipsinvestment.blogspot.com)

daxtonbrown's picture

Stagflation in the late 70's was an UNEXPECTED result of Keynesian policy - that is you shouldn't have inflation AND unemployment. The current situation is actually worse, a biflationary depression where Fed easy money policy causes not just inflation (food/gas/commodities/stocks), but deflation (homes, wages, assets) as trust evaporates and credit is withdrawn. The Bernank has been successful in bailing out his Squid banker friends and pumping the stock market, but low interest rates devastate savers by making the real rate of return negative. In short, the EXPECTED result of Keynesian money pumping is a totally fucked raisin muffin economy filled with pockets of inflation and deflation. http://www.futurnamics.com/biflation.php