James Comey Has Wrecked the QE/Market Rally Narrative
On October 29, 1929 U.S. equity markets declined 12.5%. The driver of the massive correction was news that President Herbert Hoover intended to sign into law the Smoot-Hawley Tariff. The latter would levy major taxes on over 20,000 foreign goods at record levels.
Hoover's error naturally shrank foreign markets for U.S. producers. If foreigners couldn't sell to us, they logically couldn't buy from us. Worse, tariffs as a rule subsidize the weakest producers at the expense of the most productive, all the while slowing the migration of laborers into the work that most elevates their individual talents. Investors knew the tariff would have a very negative effect on economic growth, and while Hoover didn't sign the bill until 1930, investors didn't wait to price in the inevitable, economy-sapping result. Markets corrected well ahead of the policy mistake.
Hoover's monumental miscue rates mention with recent stock-market performance very much in mind. Wise minds have been telling us for several years now that the Federal Reserve's quantitative easing program was the certain source of stock-market vitality. What a laugh.
Indeed, never explained by market and policy pundits was why the Fed borrowing $4 trillion from banks in order to purchase Treasuries and mortgages would cause the value of equities to increase. Government spending occurs at the expense of real economic growth, while raging consumption of housing was the source of substantial economic problems as recently as 2008. With good reason. Housing is not investment, nor is consumption of housing the source of economic advancement. Quite the opposite, really. The very notion that subsidization of government waste alongside a doubling down on housing would trick the most sophisticated investors in the world into bidding equity prices upward has always defied basic common sense. Still, QE mystics have promoted all manner of theories as to why what was economically harmful actually boosted stocks.
Some have said that QE provided a psychological boost to investors. Others have said QE was the Fed's communication to equity investors that the central bank would essentially have their backs. Please. What was plainly inimical to our economic health would never drive market optimism. Furthermore, never explained by the promoters of the QE narrative was why Japanese stocks, despite eleven doses of QE from the Bank of Japan since the 90s, didn't similarly surge upward in concert with the "support" of Japan's central bank. Are we supposed to believe that Bernanke and Yellen were and are uniquely skilled?
To the above, QE sleuths have responded that the Fed's actions kept yields on bonds and interest rates low such that investors exited bonds in search of higher yields in equities. The problem there is that for decades Japanese interest rates have been quite a bit lower than U.S. rates across the yield curve, but with no corresponding equity rally. Also ignored by the promoters of this iview is that the surge in U.S. equity prices never took place in concert with a major correction in Treasuries and other low-yielding securities to reflect this alleged rotation out of bonds.
Undaunted, QE mythologizers have said that the Fed's creation of $4 trillion amounted to the manufacture of an enormous search for yield that found its way into the equity markets. If we forget that the Fed didn't create $4 trillion as much as it borrowed that amount from banks only to mis-allocate it, the simple response is that for $4 trillion to enter the stock market, $4 trillion must exit that same market. For a wild-eyed QE optimist to express that optimism in the marketplace, a sober QE skeptic must be able to express an equal amount of pessimism. Markets are never all buyers or all sellers, rather markets incorporate the views of both. The passions of the bulls are always and everywhere equalized by the pessimism of the bears in what we call markets.
Important about all this is that markets never price in the present; rather they reflect the consensus view about the future. That markets corrected in 1929 (based on the broadly understood truth that protectionism would slow the U.S. economy by virtue of it slowing the global economy) to reflect pessimism about the tariff bill Hoover would sign in 1930 speaks volumes about the alleged impact of QE in modern times. While the Fed officially ended its QE program in 2014, it telegraphed cessation of what was illogical and inimical to growth and stock market health long before. This requires mention simply because if QE had been the source of the equity rally, knowledge of its end would have driven a market correction long before 2014. The obvious problem there is that stocks continued to rally right into 2014, and have mostly been on an upward path ever since.
Of course, what discredits the QE narrative the most is the argument itself. QE mythologists would have us believe that government intervention can prop up share prices artificially. Yet the obvious problem with such a view is the simple truth that the source of market rallies is capital being unstuck or dislodged from marginal companies, and being directed to better ones. Just as untouched recessions foretell subsequent booms thanks to the recession cleansing all the bad habits, bad investments and lousy companies from the marketplace, so do falling markets set the stage for bull rallies. Market vitality quite logically springs from bearish periods that relieve the lousy of precious resources. Assuming what defies common sense, that QE kept precious capital in the hands of bad companies at the expense of better ones, such a scenario would have revealed itself through a market selloff as opposed to a fairly powerful rally. The QE argument ignores why stocks take flight in the first place.
Despite the views of QE mystics, the argument has persisted that stocks are only where they are thanks to the Fed. Ok, people are welcome to their own opinions. But the big problem is that new developments continue to expose the foolhardy nature of opinions that have always lacked merit.
Further proof that QE has not been the source of equity vitality came in the form of nine straight daily declines for the S&P 500 up to last Friday. The mini market correction predictably took place after word reached investors that FBI head James Comey would be re-opening the investigation of Hillary Clinton's use of a private e-mail server. Viewed by investors as the safer choice relative to Donald Trump, investors had to begin pricing in the possibility that Clinton's legal troubles might lead to the election of an unabashed protectionist in Trump.
Going back to 1929 once again, markets are always and everywhere discounting the future, and the rising odds of a protectionist in the White House forced a re-pricing of equities. Of course, the equity pullback in response to a political development shows yet again that the Fed's role as the source of buoyant equities was always a myth. If the Fed's machinations had been the driving force behind rising equity prices, then it's foolhardy to suggest that political developments would have gotten in the way. Figure that QE mystics have all along said equities weren't strong as much as the Fed was propping them up. If so, the doings of that same Fed would have kept equities afloat no matter the potential changes in the electoral outlook. Are we to assume the Fed's balance sheet expansion coincidentally became a non-factor right as Comey made his announcement?
Much the same, are we to believe that once Comey called off his investigation on November 6th such that equities soared on the 7th that the Fed was coincidentally back at work propping up stocks? Or did investors comfortable with Clinton reflect that comfort in response to Comey's decision.
Most interesting of all, what about the U.S. equity rally that occurred the day after Trump won the election? Does anyone think a Fed he's criticized so vigorously decided to throw him a bone? Not likely. The better bet is that investors, having witnessed a more conciliatory Trump after the votes were counted, concluded a trade war wouldn't be his first priority. Let's hope he turns away from what would seriously spook investors. Time will tell.
What's no longer reasonable is for market actors to presume that the Fed is Santa Claus, only to occasionally morph into Scrooge. The very idea is silly. But then so has been the QE/stock-market rally argument always been silly. It's always been self-contradictory only for James Comey to further reveal how empty has been the view that the incompetents at the Fed could trick the deepest market in the world into a rally.
