Category Archives: Federal Reserve Bank

Federal Reserve: A Bit Player

Posted on September 6, 2016 by | Leave a comment

When talking to any number of clear headed and knowledgeable market analysts, it often shocks me at the confidence and certainty with which the Federal Reserve Bank is credited with the rebound of financials markets from 2009 to 2016.  It appears as though this assessment is guided by faith alone and yet there are numbers that seem to support the claim.  This article cannot dispel the religious reverence for the Federal Reserve’s apparent powers.  However, it is hoped that we can demonstrate that the Federal Reserve may be a bit player on a grand stage of market forces.

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Posted in 1846, 1929, Federal Reserve Bank, First Bank of the United States, Second Bank of the United States

The Nature of Market Booms and Busts

Posted on August 19, 2016 by | Leave a comment

In a recent article on SeekingAlpha.com titled “The Bigger The Boom, The Bigger The Bust” by William Koldus, it was suggested that:

  • “…we have already forgotten the lessons that should have been learned in 2008.”
  • “Monetary policy makers have set the course for the next ‘Minsky Moment.’"
  • “A good dose of volatility in both the stock and bond markets would be good for all financial market participants.”

In our review of Koldus’ work, we’ll attempt to demonstrate that analysis on stock market history should not begin with evidence that is narrowly defined. Our introduction of secular trends in the market might help put current market moves into perspective.  We’ll also show that the Federal Reserve might not be as powerful as some might think.  Finally, we hope to demonstrate that a moving market, either up or down, is good regardless of the extent and timing.

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Posted in cycle analysis, Dakin, Dewey, Federal Reserve Bank, interest rates

Interest Rate Policy: Bizarre to the Uninitiated

Posted on December 16, 2015 by | Leave a comment

On the heels of the first interest rate increase since 2006 we came an article from BloombergBusiness that should be of interest to everyone.  The article highlighted a “bizarre” theory that is quite logical and fits in well with our own long held beliefs.  That theory, touted by “Neo-Fisherians”, proposes that increasing interest rates might be what is needed to push inflation higher, as opposed to the established policy of lowering interest rates, a longstanding position of the Federal Reserve during times of crisis.

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The article contained the following thoughts:

“Many economists are so perplexed by the lack of inflation in the U.S. after years of unprecedented monetary stimulus that a bizarre, century-old theory is suddenly gaining traction: Maybe higher interest rates are what’s needed to push up consumer prices.  The idea runs counter, of course, to basically everything taught in Economics 101 classes (higher rates, we’re told, discourage rather than encourage spending and therefore curb inflation).”

This idea of “running counter to basically everything taught in Economics 101” almost explains why it may be useful and necessary for application to the current economic environment.  For the most part, Economics 101 is primarily a set of theories that apply only if all other variables remain unchanged, which is usually never the case.  It should be noted that this potential shift in policy couldn’t become an idea in the mainstream thinking until all other possibilities have been exhausted.

The article promotes the idea that the Federal Reserve somehow is on the leading edge of setting policy.  We don’t believe this to be the case.  In our November 2015 article on gold and interest rates, we said that market rate movements take place before the Federal Reserve takes action, rather than the other way around.

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In a comparable interest rate cycle, from 1948 to 1981, we can see that the discount rate followed each rise in the short-term rate.  Likewise, the most recent rate increase has followed a low and subsequent increase in the 3-month Treasury and the 10-year Treasury, as seen below.

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Another challenge is with the article’s claim that “…higher rates will make people think the economy is doing better and, as a result, they’ll start spending more. In other words, project strength and strength (as well as a little inflation) will follow.”  This line of reasoning doesn’t fit with the reality of what happens. 

Short-term rate start to rise reflecting the view that the economy has improved which is followed by similar action by the Federal Reserve.  Rising rates reflect a growing sense, and reality, of increased inflation which consumers attempt to stay ahead of by spending more current dollars.  The spending of current dollars initially is about confidence in the economy.  However, the long-term impact in a rising inflation and interest rate environment, is that it quickly becomes about spending current dollars to beating inflation.

A single rate increase by the Federal Reserve in no way makes for a trend.  However, markets often lead the way and what initially seems “bizarre” is only a natural change in regime, a change that we haven’t seen since the early 1940’s.

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Posted in 3-month, Federal Reserve Bank, interest rates

Gold Stock Indicator: November 20, 2015

Posted on November 21, 2015 by | 1 comment

Gold and gold stocks continue to languish as there appears to be no catalyst to propel prices higher. 

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The perception of no reason for gold to increase adds to the despondency of traders and investors which compels selling.  However, we’d like to point out that in spite of the conventional wisdom, the prospect of an interest rate rise is the biggest unambiguous reason for gold to increase in value.  While a Fed rate increase is what everyone is waiting for, history suggests that Fed policy  (government regulated) follows short-term Treasuries (market driven).

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In a barely perceptible way, the chart above demonstrates that all Federal Reserve rate increases were preceded by a rise in the 3-month Treasury.  The blue arrows indicate the reversal in the declining trend before 3-month Treasuries increased.  From this point, we can easily see that the Federal Reserve’s discount rate follows to the upside not long after.  We’ve only included the point in the interest rate cycle that corresponds to the phase that we are entering, coming from an all-time low to an eventual all-time high.

The price of gold cannot sustain a rise in the face of deflationary forces, which typically brings interest rates down.  As the cycle eventually turns, we will see a sustained increase in the price of gold (with the obligatory volatility).  Analysts will argue that it is not possible for the price of gold to increase in the face of rising interest rates, however, the period from 1948 to 1981 is exactly when gold had its last massive bull market (based on foreign free market price of gold from 1948-1971; U.S. price of gold from 1971-1981).

Gold Stock Indicator

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Posted in 3-month, Federal Reserve Bank, gold, gold bugs, Gold Stock Indicator, interest rates

Is the Fed Responsible for the Stock Market Rise Since 2009?

Posted on February 17, 2014 by | 2 comments

The phrase “this time is different” is often associated with a misunderstanding of the past and an unwillingness to accept time tested facts. Most often this phrase is uttered at stock market tops as an indication that basic rules of economics no longer apply. Unfortunately, there is a back door reference to “this time being different” when market analysts, of the bearish perspective, make claims that this “exceptional” market run is being fueled by the Federal Reserve Bank.

The thought is that, with all the printing of money and “quantitative easing”, the only reason that the market could possibly rise as much as it has (only +123% from the March 9, 2009 low) is because of the Federal Reserve. In this piece, we’re going to show that Fed or not, the market, after a large decline of -40% or more, retracing +50% to +100% of the prior losses is typical market behavior.

To best demonstrate our point, we’re going to start by examining the stock market at a time when there wasn’t a central bank in the U.S. from 1836 to 1914.  After all, if there wasn’t a central bank to “control” the economy then the stock market should have acted in a “certain” fashion.

The Second Bank of the United States charter ended January 1836 and was not allowed to be renewed.  However, it is important to point out that the index of leading railroad stocks had already peaked in 1835 at the level of 42 and was already in an established downtrend.  By 1842, the railroad stock index had declined to 11, or a loss of -73%.  From the low at 11 in 1842, the railroad index increased to 37 by the end of 1852, this was an increase of +236% and a recovery of +83% in the prior decline.

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From the peak of rail stocks in late 1852 at the 37 level, a decline to the 13 level by mid-1857 resulted in a loss of -64%. However, the subsequent rise from the 1857 low at 13 was followed by the rail index peaking at the 50 level by 1864, a gain of +284%.

The subsequent decline from the 50 level in 1864 to as low as 21 incurred a loss of -58% by 1877. The following rise, from 21 in 1877 to the level of 62 in 1881 was an increase of over +195%.

image After the 1881 peak in the ten leading stocks at the 62 level, the stock average promptly dropped to the 45 level in 1885, a loss of over -27%. However, the rise in stocks from the bottom in 1884 took the index to 127 in 1902, or an increase of +182%.

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The peak of 1902 at 127 was quickly followed by a decline of the leading rail stocks to 90 by 1903, a decline of -29%.  From the 1903 low of 90, the index of rail stocks peaked in 1906 at 137 for a gain of +52%.  After the peak in 1906, the index declined -37% to the low in 1907.  From the low in 1907, the index climbed to the 130 level in 1909 for a gain of +52%.  After the 1909 peak, the index declined -46% to the 69 level in 1921.  As we all know, the subsequent peak in 1929 was at the 189 level for a gain of +169%.

The most important concept that should be taken away from all this data is that a central bank did not exist from 1836-1914. There was no way to ascribe the gains of the market to the Federal Reserve. All iterations of a central bank with the First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-1836) did not have any effect on the data sets that we have provided from the period of 1836 to 1914. In order for the claim that the current market run is based on the monetary policies of the Federal Reserve, we’d need to be able to demonstrate that the stock market would have behaved differently without the existence of a Federal Reserve.

Unfortunately, those that claim “this time is different”, as in the Fed is manipulating the market higher, aren’t trying hard enough to prove their claim false. A cursory review of market data during the periods from 1836 to 1914 makes it clear that declines of nearly -40% or more are likely to retrace +66% to +100%, if not more. This pattern has been easily demonstrated in the periods after January 1914 when the current Federal Reserve system started operations. However, we’ve taken our claim about market declines and have extended it to periods when there wasn’t a central bank to show that the Federal Reserve’s role as the leading cause of the current +121% retracement of the prior decline (2007-2009) is false.

Finally, if the Dow Jones Industrial Average were to increase at the average of the gains indicated above (+236%, +284%, +195%, +182%, +52%, +52, +169%), the index would increase to 17,500 level (+167%).

Note: The above piece is an updated article that was originally posted in 2011 with the data and charts to support our latest revision (original article found here).  The difference between this posting and the one done in 2011 is that all the data is drawn from a single and separate source.  This distinction is significant since it reflects that multiple sources demonstrate similar information about how the stock market performed even when a Central Bank didn’t exist.

See Also:

Source:

  • Arthur H. Cole and Edwin Frickey. “The Course of Stock Prices, 1825-66”. The Review of Economics and Statistics. Vol. 10, No. 3, August 1928. page 117-139.
  • data and article retrieval from JSTOR. www.jstor.org

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Posted in Federal Reserve Bank, First Bank of the United States, Second Bank of the United States

QE3: A Blunt Object with Dull Impact

Posted on September 16, 2012 by | Leave a comment

On September 13, 2012, the Federal Reserve issued a statement (found here) that an additional round of quantitative easing (QE3) was going to be the preferred method for monetary policy going forward.  The  QE3  would be in the form of $40 billion of monthly purchases of agency backed mortgage securities.  The rationale for this policy implementation was explained to be put in place to ensure maximum employment and price stability.  We wonder whether a natural state of maximum employment has already been achieved.  After all,  isn’t it always at the maximum level?

It is necessary to put the implementation of QE3 into perspective.  The first official pronouncement of QE took place on November 24, 2008.  At that time, the stock market, as reflected by the Dow Jones Industrial Average, had already declined –37.66% from the October 2007 high.  The deployment of QE1 at the time resulted in a temporary bounce and then the stock market proceeded to complete the decline to the March 2009 low, an additional decline of –26%. A -26% decline as if there was no effort on the part of the Federal Reserve to stabilize the situation, speaks volumes of the relative ineffectiveness of such a policy.

The second iteration of QE took place in early November 2010.  At the time, the Dow Jones Industrial Average was already in an established rising trend (+75% above the March 2009 low) and tacked on an additional +11.94%, to the April 2011 peak.  After the April 2011 peak, the Dow Jones Industrial Average declined –15.91%.  The implementation of QE2 in 2010 was nearly 5% above the October 3, 2011 low.  Does billions of dollars of money thrown at the economy suggest that it was worth the stagnant or mild gains in the economy?

As we’ve said in our January 2011 article titled “Federal Reserve Isn’t to Blame for the Current Market Run,” and as demonstrated by the relatively mild gains and/or declining returns as represented by the Dow Jones Industrial Average, whenever monetary policy has been put in place, quantitative easing has little impact on the expected outcome for where the stock market and economy will go.  Additionally, we've shown how in periods when the Federal Reserve didn't exist (1864-1913), the stock market would routinely rebound 50% to 100% of prior losses.

Why do we make comparisons between the stock market and Federal Reserve policy when actions taken by the Fed are intended to affect economic activity and not the stock market?  The answer lies in a 2004 paper, co-authored by Ben Bernanke before he became Fed chairman, titled “Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment” which is THE basis for quantitative easing in the United States.  On page 8 of the 113 page document, step one for effective QE (out of three) is stated as follows:

“..using communications policies to shape public expectations about the future course of interest rates…[1]”

This is significant because the stock market is the court of public opinion on all matters relating to current and future economic expectations.  Dow Theory, a 110-year old approach to interpreting the stock market, has the following to say on this matter:

“The Averages Discount Everything — The fluctuations of the daily closing prices of the Dow-Jones rail and industrial averages afford a composite of all the hopes, disappointments, and knowledge of everyone who knows anything of financial matters, and for that reason the effects of coming events (excluding acts of God) are always properly anticipated in their movements.[2]”

All initial communications by the Federal Reserve are meant to sway the public and is voted on by the stock market either rising or falling in acceptance or rejection of the Federal Reserve’s communiqué. The book by Benjamin Graham titled Security Analysis highlights the point that the market is an arena where votes are cast in the following quote:

“The stock market is a voting machine…[3]”

We believe that the Federal Reserve decides exactly how much they have to follow through with their “communication policies” based on the magnitude of the reaction from the financial markets.

For us to believe that quantitative easing is an effective tool in the court of public opinion and ultimately for the economy, we'd like to see both the Dow Jones Industrial Average and Dow Jones Transportation Average to exceed previous all-time highs on the news.  Unfortunately, the latest announcement has not catapulted both indexes to new highs which, according to Dow Theory, puts the latest policy initiative in question.

Although there is little to demonstrate that monetary tools being put in place, like quantitative easing, are actually effective, what we are seeing is an emerging trend in when the Federal Reserve decides to take action.  In the chart below we see that when the percentage change from a year ago of real gross domestic product (GDP) has peaked, the Federal Reserve will attempt to take steps to stop the declining trend of GDP.

image

Keep in mind that since QE2, real GDP growth has still managed to trend lower than the period before, on a percentage basis.  This is not the ideal outcome of massive amounts of “liquidity” being “created.”  As can be seen in the chart above, the overall trend in year-over-year (y-o-y) percentage growth in real GDP has reflected a pronounced declining trend in alignment with the peaks of 2000 and 2004.  However, in the entire history of collected y-o-y percentage growth in real GDP, since 1947, the declining trend has been well established and should not be considered a new phenomena.

The fact that QE2 could not demonstrate y-o-y growth greater than the 2010 peak before QE3 was implemented suggests that the stock market and economy are easily susceptible to a major “shock” in spite of the Federal Reserve’s best efforts.  An additional takeaway from our interpretation is that, unless under “emergency conditions,” the Federal Reserve Bank will implement massive amounts of renewed quantitative easing if real GDP appears to have peaked as was the case shortly before the QE3 announcement on September 13, 2012.

[1] Ben S. Bernanke, Vincent R. Reinhart, and Brian P. Sack. “Monetary Policy Alternatives at the Zero Bound:
An Empirical Assessment.” Federal Reserve Bank, Washington D.C. 2004. PDF found here.

[2] Rhea, Robert. The Dow Theory. 1932. Barron’s Publishing, page 19.

[3] Graham, Benjamin. Security Analysis. 1934. page 452. found here.

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Posted in Federal Reserve Bank, GDP, Quantative Easing

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Federal Reserve Isn’t to Blame for the Current Market Run

Posted on January 19, 2011 by | Leave a comment

The phrase “this time is different” is often associated with a blithe understanding of the past and an unwillingness to accept time tested facts. Most often this phrase is uttered at stock market tops as an indication that basic rules of economics no longer apply. Unfortunately, there is a back door reference to “this time being different” when market analysts, of the bearish perspective, make claims that this “exceptional” market run is being fuel by the Federal Reserve.

The thought is that, with all the printing of money and “quantitative easing”, the only reason that the market could possibly rise as much as it has is because of the Federal Reserve. In this piece, we’re going to show that Fed or not, the market, after a large decline of nearly -50% in one stretch, retracing +50% to +100% of the prior losses is typical of the market.

Starting with the period from 1861, the average price of the ten leading stocks (rails), based on trading volume, went from the level of 50 to as high as 141 in early 1864. The subsequent decline from 141 in 1864 to as low as 43 incurred a loss of -69% by 1877. The following rise, from 43 in 1864 to the level of 121 in 1881 was an increase of over +79%.

After the 1881 peak in the ten leading stocks at the 121 level, the stock average promptly dropped to the 65 level in 1884, a loss of over -46%. The rise in the ten leading stocks from the bottom in 1884 took the index to 102 in 1890, or an increase of +66%.

The peak of 1890 at 102 was quickly followed by a decline of the leading stocks to 60, a decline of -41%. After trading in a tight range until 1898, the leading stocks rose to 180 by 1905, a gain of +200% in eight years.

The preceding examples were derived from the book “Wall Street and the stock markets: A chronology (1644-1971)” by Peter Wyckoff on pages 38 and pages 39. For those interested, Wyckoff specifics exactly which stocks were initially included in the leading stocks and which stocks were added and dropped in the period following.

Switching to the Dow Industrials from 1906 to 1922. Below, we are republishing the data from our timely article dated February 12, 2009 titled “Misinformed Market Observations” (found here). In that article we show that declines of -40% or more resulted in rebounds of +50% to +100% of the previous decline.

  • Jan 19, 1906 to Nov. 15, 1907 decline of -48.3%
  • Nov. 15, 1907 to Nov. 19, 1909 increase of +89%
  • Sept. 30, 1912 to Dec. 24, 1914 decline of -43%
  • Dec. 24, 1914 to Nov. 21, 1916 increase of +107%
  • Nov. 21, 1916 to Dec. 19, 1917 decline of -40%
  • Dec. 19, 1917 to Nov. 03, 1919 increase of +81%
  • Nov. 3, 1919 to Aug. 24, 1921 decline of –46%
  • Aug. 24, 1921 to Oct. 14, 1922 increase of +61%

The most important element that should be taken away from all this data is that the current Federal Reserve did not exist prior to January 1914. There was no way to ascribe the gains of the market to a central bank. All iterations of a central bank with the First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-1836) did not have any effect on the data sets that we have provide from the period of 1860 to 1914. In order for the claim that the current market run is based on the monetary policies of the Federal Reserve, we’d need to be able to demonstrate that the stock market would have performed differently without the existence of a Federal Reserve.

Unfortunately, those that claim “this time is different” aren’t trying hard enough to prove their claim false. A cursory review of market data during the periods from 1860 to 1914 makes it clear that declines of nearly -50% or more are likely to retrace +66% to +100% of prior declines. This pattern has been easily demonstrated in the periods after 1914. However, we’re only trying to illustrate that the acceptance of the Federal Reserve’s role as the leading cause of the current +69% retracement of the prior decline (2007-2009) is false.

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Posted in Federal Reserve Bank, First Bank of the United States, Second Bank of the United States

Real Estate Bottom is Calling

Posted on January 6, 2010 by | Leave a comment
The great real estate analyst Roy Wenzlick may have called the bottom in real estate again...for the 10th time in a row for the last 78 years. Although he passed away in 1989, Roy Wenzlick gave significant credibility to the idea that real estate has an 18.3 year cycle. Wenzlick compiled data on real estate in St. Louis as well as the rest of the nation from 1932 until 1973 in his publication The Real Estate Analyst.In the diagram below, you will see Wenzlick's 18.3 year cycle displayed from 1795 until 1973.
 
It is important to note that if you add 18 years to 1973 you get the year 1991 as the next period for a low in the real estate market. Coincidentally, to some, 1991 was the last time we had a bottom in the real estate market. If you add another 18 years to 1991 then you get 2009. My tendency has been to include the years 2008 and 2010 just to play it safe.
 
As a way to cross reference our perspective that the bottom is coming, I have included the Federal Reserve's data on real estate loans with the percentage change from the previous year. Although real estate loans by banks is a slightly lagging indicator it has tracked the performance of the real estate market in sync with the Wenzlick model.
 
If we haven't hit bottom yet it means that within the year 2010 we will have to go below the previous low prices of 2009. Such an occurrence would be a complete disaster for the financial markets. I am hopeful that the real estate market doesn't further devolve. However, the concern does rest in the back of my mind.
 
Barring any further crisis in real estate, I'm willing to go out on a limb and say that on the whole, as opposed to specific geographic regions, based on credible sources like Wenzlick, the bottom in real estate may be in.
 

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Posted in Federal Reserve Bank, real estate, Wenzlick