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Pavlov's Market

Submitted by Tyler Durden on 10/26/2015 15:35 -0400

Submitted by Joseph Y Calhoun via Alhambra Investment Partners,

Stocks rallied strongly last week in response to comments by Mario Draghi that signaled a willingness, a determination in fact, to engage in more monetary stimulus. In fact, Draghi seemed to promise – once again – to do “whatever it takes”, offering to consider “a whole menu of monetary policy instruments” in saying that the ECB was now “vigilant”. One wonders why they were less than vigilant before last week but the market didn’t much care about that. Apparently the use of the V word is code in Europe for more interest rate cuts – a minus sign by itself apparently not sufficient to revive the sclerotic European economy – something of which I was blissfully unaware until Friday. Stock market punters certainly got the message and bid stocks higher the world over, presumably in anticipation of better growth.

Why exactly more monetary stimulus now – after repeated applications of extreme policy in recent years – should be expected to produce more growth is a bit of a mystery. To date, there is no country one can point to and say that QE was an unmitigated success, that it restored a country’s economy to full health. And I doubt there ever will be since it only gets applied in countries or regions that are having severe economic problems, generally ones that are immune to monetary nostrums. You can’t fix fiscal and regulatory problems with more bank reserves and a cheaper currency.

Nevertheless, monetary stimulus in whatever form has become associated since the last economic crisis with rising stock prices and the mere hint of more stimulates, if nothing else, the algorithms that do most of the trading these days. Like Pavlov’s dogs, no actual stimulus is even required. A hint, a dog whistle or just weak economic data will do. Anything that rings the monetary bell triggers the risk taking salivary glands.

The connection between monetary stimulus and the stock market is a tenuous one that runs, ultimately, through corporate profits and therefore, to some degree, economic growth. In the past, monetary stimulus – rate cuts – was associated with weak stock market performance because it was applied when the economy was weakening and there was a presumed lag between a change in policy and its ultimate effect. Monetary policy works with long and variable lags as the economists put it. So, monetary stimulus was good for stocks but not right now; more stimulus was a sign of failure, that previous cuts weren’t sufficient, in the judgment of the central bank, to revive growth.

In the 2000 recession and bear market, the Fed cut the Fed Funds rate from 6.5% to 1% over a period of roughly three years and the stock market fell for almost the entire time. In the last recession and bear market the Fed cut the Fed Funds rate from 5.25% to the current 0 – 0.25% range starting in July 2007. The stock market fell, again, almost the entire time rates were being cut. In both cases, the economy eventually turned the corner, earnings improved and stock prices followed. Whether that was due to monetary policy or in spite of it is hard, maybe impossible, to determine.

QE supposedly works differently, through the portfolio balance channel, a mixture of wealth effect and forced risk taking. QE removes high quality bonds from the market and forces investors to move out on the risk scale to replace the Treasuries they sell to the Fed. The effect is to reduce corporate borrowing costs in the hope that the borrowers will find something productive to do with the extra cash. Further, because QE forces more buyers into the private sector bond markets it raises the price of those assets. The owners of those assets feel wealthier and will presumably spend more, further stimulating economic growth. The European version is slightly different but looks to accomplish the same thing – force capital into the private sector. That’s the basic theory anyway.

That it hasn’t really worked that way is apparently no impediment to those unconcerned with correlation and causation. The fact that stock prices have risen during periods of QE is not sufficient to prove that QE caused higher stock prices. It may have been something else that caused stock prices to rise and if so, it would seem pretty important to figure that out before acting – buying – on promises of more stimulus. One might also consider why Draghi and the ECB believe more stimulus is needed and whether policy really does work with long and variable lags.

Stock prices are ultimately about earnings and the discount rate one applies to them. Monetary policy can have an impact on the discount rate directly but its influence over earnings is much less. There are many things that affect profit margins and earnings per share, most of them having little to do with interest rates or even economic growth for that matter. And since rates have been at this depressed level since 2008 one would think that stocks are no longer moving on expectations of a lower discount rate. That leaves earnings as the primary driver of stock prices and for anyone buying on the ECB QE and China rate cut news that might present a problem.

The immediate effect, besides pushing up stock prices, was a rise in the value of the dollar versus the Euro and the Yen. It seems to have been forgotten in the hoopla, the conditioned response to more monetary cowbell, but it was only a couple of months ago that the world’s stock markets were reacting pretty negatively to a strong and steadily rising dollar. And for good reason if recent earnings reports are any indication. If stocks follow earnings – and ultimately they do – a rapidly rising dollar isn’t going to be a positive development for US multinational companies. It also isn’t good news – still – for countries trying to stem capital outflows.

Neither is it necessarily a positive development for the rest of the global economy. I have always been mystified that a strategy that drives capital away is considered stimulus. A more logical strategy would be to enact policies that attract capital not repel it. In fact, a cheaper currency doesn’t solve any problem; it is merely an acknowledgment of past economic mistakes. A cheaper currency doesn’t make a country poorer; it is a revelation of its true worth. It is the country’s other economic policies that made it poor, a falling currency and the policy that produces it being merely the market’s expression of that failure.

It was only a couple of months ago that a rapidly rising dollar was pushing the global economy closer to a new crisis. It seems unlikely that the conditions that made a rapidly rising dollar a problem in August have all been resolved by October. Those who bought stocks last week in response to hints of more easing from Draghi – and the rate cut in China – may find themselves in the same position as Pavlov’s dogs, wondering why no meal follows the ringing of the bell.

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Mon, 10/26/2015 - 15:40 | 6713204 Elliott Eldrich

Freud for the masses, Pavlov for the insiders. Once you grasp what was done with that information, a lot of other stuff starts making sense.

Mon, 10/26/2015 - 16:38 | 6713588 ZoroAustrian

'The connection between monetary stimulus and the stock market is a tenuous one that runs, ultimately, through corporate profits and therefore, to some degree, economic growth.'

What planet has this guy been living on? Stock market has nothing to do with corporate profits and economic growth, rather has everything to do with relentless free money being thrown directly at it, bypassing the economy. i.e. a direct connection between monetary stiumulus and the stock market.

How can people still trot out this Economics 101 garbage. They threw away the last textbooks (and the rulebooks) in 2008.

Mon, 10/26/2015 - 16:50 | 6713647 junction

Speaking of animals and criminals, there is news now of a valuable show horse that monsters slaughtered in Florida for its meat, the crime done at the horse's stable. Anything now goes in the USA, a land where desperate criminals can with impunity steal the world's wealth or carve up a horse worth tens of thousands of dollars just for its value as horse meat. This story shows doomsday preppers have a point, that civilization around us is collapsing. With nary a word from NWO flunkies like Obama and Zuckerberg. Who knows if there are not now high placed cannibals out there in America doing the same to humans as those ghouls did to that show horse. Don't ask FBI director Comey, he is more concerned with getting the right dye to turn his hair and sideburns bottle black.

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1,300-Pound Show Horse Slaughtered on Florida Farm

Tamara Lush, Associated Press

St. Petersburg, Fla. — Oct 26, 2015, 4:21 PM ET

Just days ago, the nearly 1,300-pound, powerful jumping horse with a shiny chestnut coat named Phedras de Blondel arrived at his new home in the U.S., a farm owned by a champion rider in Florida.

On Sunday morning, his owner discovered a horrific scene near his stall: the 12-year-old gelding had been slaughtered and butchered, most likely for his meat. Only his head and neck were left intact. Now, detectives are trying to find the perpetrators.

"What they did to this horse had nothing to do with his value," Debbie Stephens, who owns the 27-acre ranch in Palmetto, said Monday. She would not disclose the price she paid for the horse, but show horses can sell for tens of thousands of dollars. "It's one of the cruelest things that could happen to any horse. This just turned my life around."

Stephens is a veteran show jumper and holds the women's high jump record of 7 feet, 8 inches. Her husband was a co-designer of the show jumping courses for the 2008 Olympic Games in China.

The couple and others have raised more than $18,000 toward a reward they hope will lead to an arrest. Manatee County Sheriff's deputies say that's what it will take to crack the case.

Horse meat is illegal in Florida, but a black market for it exists, said Nick Atwood, a spokesman for the Animal Rights Foundation of Florida. During the 2010 Florida Legislative Session, he said, a bill passed that strengthened the state's restrictions on the sale of horse meat for human consumption. It is now illegal in Florida to sell, purchase, distribute, transport or possess horse meat unless "it is clearly stamped, marked, or described as horse meat for human consumption."

There are currently no U.S. slaughterhouses that process horse meat, however, making it difficult to obtain legally.

While eating horse meat is generally taboo in the U.S., it is common in dishes in some Caribbean and European countries. Atwood said there are some people living in the U.S. willing to pay top dollar.

It's not the first time horses have been targeted for meat in Florida. In July, animal rescue officials said a competitive show horse named "Smart Amanda Whiz" was slaughtered for its meat in Hialeah. And earlier this month, officials in Palm Beach County raided three slaughterhouses accused of illegally selling horse meat.

"The horses are slaughtered horribly," Atwood said. "There's no illusion of humane slaughter."

That's the case with Phedras, said Stephens, who said the horse was friendly and probably went with his killers willingly. She said he was likely still alive when they began to butcher him.

She said probably more than one person was involved in the slaughter because the horse was so big.

The horse was probably targeted because of his size, officials said.

"It could be the suspects scoped out this ranch," said Dave Bristow, a spokesman from the Manatee County Sheriff's Office. The ranch is not far from the interstate.

Stephens said she's reinforcing her ranch to protect the other 50 horses that live on the property — and she's planning to raise more money for the reward and speak out about the problem of illegal horse slaughter. Florida is a popular state for show horses, and she wants to protect other animals and owners.

"This can happen to anyone's horse," she said.

http://abcnews.go.com/US/wireStory/officials-champion-show-horse-killed-butchered-florida-34736722

Mon, 10/26/2015 - 15:42 | 6713211 ZippyBananaPants

Everyone knows that dogs can't buy stocks. Where are we going with this?

Mon, 10/26/2015 - 16:02 | 6713346 Bernoulli

Not all dogs would beat the market but I'm pretty sure some of them would do a pretty decent job at picking stocks. Probably a lot better than the average "financial advisor".

Mon, 10/26/2015 - 16:04 | 6713348 Dead Canary