Authored by MarketWatch's Howard Gold [14], via Contra Corner blog [15],
Things were looking grim last week, especially on Wednesday, when the Dow Jones Industrial Average was at one point down by 460 [16].
The CBOE VIX indicator soared to the mid-20s for the first time in two years. Fear was palpable as investors had a classic panic attack [17].
But then, like the cavalry in those classic John Ford westerns, the Federal Reserve rode to the rescue.
James Bullard, president of the Federal Reserve Bank of St. Louis, said inflation far below its 2% target could lead the Fed to “go on pause on the taper [18] … and wait until we see how the data shakes out into December.” The Fed is on track to finish “tapering” its extraordinary bond buying, or quantitative easing (QE3), at next week’s meeting.
‘They are afraid of the [stock] market going down and they will be blamed.’
James Bianco, president of Bianco Research
But, he added: “If the market is right and it’s portending something more serious for the U.S. economy, then the committee would have an option of ramping up QE [in December].”
Boston Fed President Eric Rosengren later said QE3 should end next week, but he could “easily imagine [19]” not raising rates until 2016.
Translation: We’ve got your back. Don’t fight the Fed.
Investors got the message. The S&P 500 Index advanced for three straight days and the VIX fell under 20 again.
Bullard was only the latest Fed official whose words or actions “just happened” to boost the stock market when it was down.
“They are definitely in the market-manipulation business, and nothing has changed,” said James Bianco, president of Bianco Research LLC in Chicago and a longtime student, and critic, of the Fed.
Called the “Greenspan/Bernanke put,” the Fed’s willingness to jump in when stocks fall dates back a quarter-century.
“The put option is back. If the market sells off enough, they will give us QE4,” Bianco told me.
Conspiracy theorists have pinned it on a government “Plunge Protection Team [20]” that wants to keep stocks from crashing at all costs.
But conspiracy or no, consider these actions [21]:
Aug. 31, 2012: In his annual speech in Jackson Hole, Wyo., Fed Chairman Ben S. Bernanke all but announced [22] the third round of QE, extraordinary bond buying of $85 billion a month. The S&P 500, which had languished after a nearly 10% decline, rallied from 1,399 points and hasn’t corrected substantially until now.
Sept. 22, 2011: Following a 19.4% stock sell-off amid a debt crisis in Europe and the U.S., the Fed launched Operation Twist [23], in which it sold short-term and bought long-term securities to push down long rates. After first slipping, the S&P 500 resumed a multiyear take-off that, with a little help from the Fed, ultimately drove it 80% higher.
Aug. 27, 2010: In another famous Jackson Hole speech, Bernanke vowed the Fed would “do all that it can [24]” and would “provide additional monetary accommodation through unconventional measures if … necessary.” After a 16% correction in the S&P 500, the Fed’s purchase of $600 billion in securities through QE2 would help push stocks 22.8% higher, according to Bianco Research.
Nov. 25, 2008: In the heat of the financial crisis, Bernanke announced the Fed’s first bond-buying program in which it wound up purchasing $1.7 trillion worth of securities. QE helped launch the new bull market and drove the S&P 500 up 50%.
“Three times they put down markers they were going to end QE,” Bianco said. “In all three cases — 20%, 17%, 10% down in the stock market — they reversed.”
As this terrific chart shows, Bianco Research estimates that during all the QEs, stocks rose by 147.5%. Subtracting periods of QE, they lost 27.5%.
Back in the fall of 1998, Alan Greenspan cut rates three times [26] during the Asian/Russian financial crisis and after the bailout of Long-Term Capital Management. That set the stage for the 1990s bull market’s final blow-out phase.
[25]
And after the 1987 stock market crash, when the Dow fell 22.6% in a single day, Greenspan’s Fed bought $17 billion worth of bonds (a lot in those days) and declared the central bank ready “to serve as a source of liquidity [27] to support the economic and financial system.” The panic eased and the bull continued for years.
As in 1987, the specter of 1929 still haunts the Fed. “They are afraid of the market going down and they will be blamed,” explained Bianco. If that means “guiding” the stock market, so be it.
Problem is, Congress gave the Fed a mandate to “promote maximum employment, production, and price stability [28]”; it never explicitly authorized propping up stocks. Yet through a remarkable theoretical stretch called the “wealth effect,” that’s exactly what the Fed is doing.
Don’t get me wrong: This bull market reflects a genuine, albeit below-normal, recovery, and the U.S. is much stronger than the rest of the world [29]. The Fed helped by giving the economy time and breathing room.
But the emergency is over and once accumulated, power is not easily shed. If this pattern continues, the U.S. economy and markets will never stand on their own feet again.
This may be the ultimate test for Janet Yellen and could determine whether she’s remembered as a great Fed chair or just another caretaker of a dead-end course if there ever was one.
