Trump's Right - Morgan Stanley Warns "Big, Fat, Ugly Bubble" Is "An Illusion" Driven By The Fed

Tyler Durden's picture

Authored by Morgan Stanley Chief Global Strategist Ruchir Sharma, originally posted op-ed via The Wall Street Journal,

The press spends a lot of energy tracking the many errors in Donald Trump’s loose talk, and during Monday’s presidential debate Hillary Clinton expressed hope that fact checkers were “turning up the volume” on her rival. But when it comes to the Federal Reserve, Mr. Trump isn’t all wrong.

In a looping debate rant, Mr. Trump argued that an increasingly “political” Fed is holding interest rates low to help Democrats in November, driving up a “big, fat, ugly bubble” that will pop when the central bank raises rates. This riff has some truth to it.

Leave the conspiracy theory aside and look at the facts: Since the Fed began aggressive monetary easing in 2008, my calculations show that nearly 60% of stock market gains have come on those days, once every six weeks, that the Federal Open Market Committee announces its policy decisions.

Put another way, the S&P 500 index has gained 699 points since January 2008, and 422 of those points came on the 70 Fed announcement days. The average gain on announcement days was 0.49%, or roughly 50 times higher than the average gain of 0.01% on other days.

This is a sign of dysfunction. The stock market should be a barometer of the economy, but in practice it has become a barometer of Fed policy.

My research, dating to 1960, shows that this stock-market partying on Fed announcement days is a relatively new and increasingly powerful feature of the economy. Fed policy proclamations had little influence on the stock market before 1980. Between 1980 and 2007, returns on Fed announcement days averaged 0.24%, about half as much as during the current easing cycle. The effect of Fed announcements rose sharply after 2008 when the Fed launched the early rounds of quantitative easing (usually called QE), its bond purchases intended to inject money into the economy.

It might seem that the market effect of the Fed’s easy-money policies has dissipated in the past couple of years. The S&P 500 has been moving sideways since 2014, when the central bank announced it would wind down its QE program.

But this is an illusion. Stock prices have held steady even though corporate earnings have been falling since 2014. Valuations—the ratio of price to earnings—continue to rise. With investors searching for yield in the low interest-rate world created by the Fed, the valuations of stocks that pay high dividends are particularly stretched. The markets are as dependent on the Fed as ever.

Last week the Organization for Economic Cooperation and Development warned that “financial instability risks are rising,” in part because easy money is driving up asset prices. At least two regional Fed presidents, Eric Rosengren in Boston and Esther George in Kansas City, have warned recently of a potential asset bubble in commercial real estate.

Their language falls well short of the alarmism of Mr. Trump, who in Monday’s debate predicted that the stock market will “come crashing down” if the Fed raises rates “even a little bit.” But it is fair to say that many serious people share his basic concern.

Whether this is a “big, fat, ugly bubble” depends on how one defines a bubble. But a composite index for stocks, bonds and homes shows that their combined valuations have never been higher in 50 years. Housing prices have been rising faster than incomes, putting a first home out of reach for many Americans.

Fed Chair Janet Yellen did come into office sounding unusually political, promising to govern in the interest of “Main Street not Wall Street,” although that promise hasn’t panned out. Mr. Trump was basically right in saying that Fed policy has done more to boost the prices of financial assets—including stocks, bonds and housing—than it has done to help the economy overall.

The increasingly close and risky link between the Fed’s easy-money policies and financial markets has been demonstrated again in recent days. Early this month, some Fed governors indicated that the central bank might at long last raise interest rates at its next meeting. The stock market dropped sharply in response. Then when decision time came on Sept. 21 and the Fed left rates unchanged, stock prices rallied by 1% that day.

Mr. Trump was also right that despite the Fed’s efforts, the U.S. has experienced “the worst revival of an economy since the Great Depression.” The economy’s growth rate is well below its precrisis norm, and the benefits have been slow to reach the middle class and Main Street. Much of the Fed’s easy money has gone into financial engineering, as companies borrow billions of dollars to buy back their own stock. Corporate debt as a share of GDP has risen to match the highs hit before the 2008 crisis.

That kind of finance does more to increase asset prices than to help the middle class. Since the rich own more assets, they gain the most. In this way the Fed’s policies have fueled a sharp rise in wealth inequality world-wide—and a boom in the global population of billionaires. Ironically, rising resentment against such inequality is lifting the electoral prospects of angry populists like Mr. Trump, a billionaire promising to fight for the little guy. His rants may often be inaccurate, but regarding the ripple effects of the Fed’s easy money, Mr. Trump is directly on point.

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1980XLS's picture

Time for the Donald to Bitchslap Janet

847328_3527's picture

"Lock her up!"


Not even Cape Breton will accept criminals, no matter how Big they are.

Luc X. Ifer's picture

I don't recommed searching for refuge when you are a famous notorius liar and con artist in a small community/social enclave where resilient people survive by face-value trust and mutual help.  

DavidC's picture

Maybe I'm misreading the article but in January 2008 the S&P was at around 930 (it hit its low of 666 and a bit) in March) - it's now around 2155. That's a rise of 1225 points NOT 699.


Escrava Isaura's picture

Trump's Right: I am Big, Fat, Ugly Bubble Illusion Driven By The Fed.


Father ¢hristmas's picture

It's always fun to see how different the world outside of Zero Hedge is.  Guys are like six years behind.

Escrava Isaura's picture

Like 2008 “It came from nowhere. No one ever saw it coming”.

By the way, being at Zero Hedge doesn’t mean that you get it, that you connected the dots. It takes lots of years, and one’s ability to step outside one’s biases to decipher between today’s lies with yesterdays facts.



monad's picture

That one was so obvious even Captain Obvious called it early

jfb's picture

Those guys don't know what they are talking about. When the temperature is too hot I simply break my thermometer, it always work.

DOGGONE's picture

The public be suckered! Look at this rarely seen price history:

asscannon101's picture

It has been accurate for several years that, 'The Fed does not run the Market, the Market runs the Fed', and anyone who can chew their own food knows that.

asscannon101's picture

Sorry. Double-tap. It went off in my hand.

Biffkenson's picture

Morgan Stanley was only a few hours from disappearing in October 2008 when they were bailed out by a Japanse bank I think it was Sumitomo Mitsui Bank, whatever they have to say is less than relevant.

inosent's picture

I think DT has been right on pretty much everything. Not that is was so hard, as he only has been stating the obvious.

Oldwood's picture

Without big giant fucking bubbles, what else would we have to look forward to. God only knows you can't make "money for nothing" without them....and that IS our current economic model, is it not?

sheikurbootie's picture

Trump is right about a lot of things.  I've seen many of the same sights.  I've traveled the world many times, lived/worked as an ex-pat for many years.  The world is kicking our ass.  America isn't respected anymore.  When I was growing up overseas the dollar could be used as ANY local currency.  You didn't need to exchange your money the dollar was PREFERRED to the local currency.  Fast forward to the 90's when I lived/worked overseas.   No one would accept the dollar and some didn't even know what it was.  I remember vividly this one middle aged adult asking "what is this?" like it was toilet paper.   The dollar was dying then, it's dead now. 

Everyone hates us around the globe.  Not many people respect the US.  We've been in the backyards too many times and fought too many wars.  Clinton's world police bullshit finished us off. 

Trump is also right about China, middle east, etc having nicer airports and increasingly better infrastructure than we do.   The latest US bridge report was telling.  How about the fucking roads in NYC?  What a shithole.  Interstates around the US are pitiful compared to the German autobahn.  It's perfect all the time.  Well designed with positive angle slopes like a race track. US road designers suck.

I doubt Trump can fix most of our problems, but maybe we can get a wall and stop illegals from entering.  It's a start.  My police friends have been about to explode over the illegals for over a decade.  Nothing happens to them when turned over to the Feds.  Actually, the Feds now refuse to even pick them up from the local police.  True story, ask a cop. 

RadioFlyer's picture
RadioFlyer (not verified) sheikurbootie Sep 29, 2016 11:45 PM

Trump sucks on wanting to destroy our 4th amendment rights by a massive NSA surveillence state and jamming Stop & Frisk on all of us.

He is a statist and a Democrat. read his books.

DIGrif's picture

Their language falls well short of the alarmism of Mr. Trump, who in Monday’s debate predicted that the stock market will “come crashing down” if the Fed raises rates “even a little bit.” But it is fair to say that many serious people share his basic concern.


He is 100% correct.

DavidC's picture

Trump's right.

Ar a Fed rates range of 25 to 50 basis points, if the Fed raises by 25 basis points that's an increase of between 50% and 100% of interest rate burden. I appreciate that that's not what we pay, but the banks are stretched out as far as they can be on these low Fed rates, not to mention effective negative rates with the ECB and BoJ. negative rates.

Compare that with a rate at 5%, rate change of 25 basis points is a 5% change.

By having rates hammered to the floor, any rate changes now are going to be comparatively MUCH more dangerous.

Trump is right.