One week ago [15], we explained what happened to both the US economy and the stock market the last time the Fed tightened financial conditions back in 1936 when it, like now, erroneously thought the economy was strong enough to sustain it:
"The Fed exit strategy completely failed as the money supply immediately contracted; Fed tightening in H1’37 was followed in H2’37 by a severe recession and a 49% collapse in the Dow Jones."
This is what it looked like courtesy of BofA strategist Michael Hartnett:
[16]
We concluded with the following:
As can be seen on the above, in 1938, the stock market began to recover some. However, despite the easing stocks didn't fully regain their 1937 highs until the end of the war nearly a decade later.
It needed a world war for that.
Alas, the sad reality that a war is what will be needed to get out of the ridiculous broken market/record debt state the world finds itself in due to the unprecedented central bank intervention over the past 7 years to make the rich richer, is spreading.
Today we read from none other than the same Bank of America strategist who points out that while the Fed's next step may well be the opposite of success, i.e., quantitative failure, the resulting shock to the system will have to endure the same type of catharsis, as what "saved" the US financial system from the first Great Depression.
To wit:
The rotation from growth to value, DM to EM and so on, could occur in a bad way, following a potential Quantitative Failure.
The clash between a tightening Fed, QE in Europe & Japan, and potential devaluations in China & Saudi Arabia mean 2016 “tail risks” are high in our view. BofAML forecasts a 10% devaluation of the Chinese renminbi in 2016, and regards a de-pegging of the Saudi riyal as a potential “black swan”. Like a game of Jenga, a bull market built by central banks can collapse if further BoJ/ECB QE and Fed hikes engender US dollar spikes and EM/commodity swoons, FX-wars and volatility. 1937, 1987 & 1994 were all years of “policy divergence” and all years of market crashes.
If deflation intensifies, causing bear markets and recessions, investors should ultimately anticipate a major policy shift in 2016...in US/EU/Japan from QE to fiscal stimulus. A flip to fiscal stimulus is the most likely catalyst for a Great Rotation out of “deflation plays” into “inflation plays”, undoubtedly the biggest investment decision of 2016. Sadly it took the New Deal and WW2 to end the dominance of “growth” over “value” in the 1930s.
What Mr. Hartnett failed to mention, is that in addition to forcing the rotation out of "growth" and into "value" stocks - hardly the most important consequence of, well, a global war - it also took World War 2 to pull the US out of the Second Great Depression.
Which may also explain why currently in the Syria proxy war there already are US, British, French, German, Saudi, Turkish, Russian, Iranian (and shortly Chinese [17]) forces in the air and on the ground. Because if the $200 trillion in global debt will not inflate itself on its own, it may just need the "push" of a few million tons of TNT to get it rolling.
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