I am not one of those guys who takes a chart from 1929 and sticks it over the current Dow Jones chart and proclaims the end of the world is nigh. I don’t buy for one second the idea any market has to follow the same path as some previous trading pattern.
I firmly believe the future direction of markets is undetermined. There are outcomes which are more likely, but no one knows for sure which way the markets are headed.
Take for example the 2008 credit crisis. If Bernanke had been of a different philosophical bent, then he might not have come riding in with Quantitative Easing programs. If there had no been no QE, we probably would have crashed much further, and rebounded much less. The direction of the market was therefore very much up in the air. The actions of one individual greatly affected the outcome of the whole market. How could you make a prediction on that? Or take 9/11. You could have the greatest “chart analogy” in the world, but how could you forecast the actions of a small group of deranged terrorists? The answer is you can’t, and anyone who tells you they know where the market is headed with certainty is lying.
Yet even though the future direction of the market is uncertain, there are moments in history that resemble one another. The details are slightly different, but the bigger picture is more similar than would be the case in a truly random sample.
Recently I was thinking about Obama’s legacy. I was reflecting how he has experienced no truly bad economic or market events. Of course he inherited one of the worst economies in modern economic history, but since taking office, it has basically been straight up.
The economy bottomed in March of 2009 three months after Obama was sworn in. The newly elected President had to deal with three bad job reports until the direction reversed, and has only headed one way since.
Even the stock market, which was predicted to collapse due to the election of the left leaning Obama has been a one way ticket higher. Remember the right wing’s doomsday predictions after Obama trounced Romney? Here’s a Rush Limbaugh quote that reflected the mood at the time:
OK, so let me start at the top here connecting the dots. On Tuesday we elect a new president. New president promised even before the election, by the way, when we had a 4,000-point drop — the president promised to increase corporate taxes, capital gains taxes, the top marginal income tax rate, a massive new energy tax that’ll bankrupt coal. And his party is talking about a government takeover of 401(k) plans.” Limbaugh continued: “So on Wednesday, the Dow drops about 486 points. It’s down 346 points today. But of course, according to the drive-bys, these two events have nothing to do with each other. It’s just a coincidence. The market’s down today because of the jobless numbers. That’s how the drive-bys see it. We have the largest market plunge after an election in history. Thank you, man-child Barack Obama.”
This quote is all the more funny in hindsight. Far from causing a market crash, Obama has presided over a 110% increase in the stock market during his two terms as President.
I am by no means attributing the rising stock market on Obama’s policies. He had little to do with the monster rise.
However, it is interesting that since those early days in office, Obama has never been tested with a true economic crisis.
President Obama is now a little more than a year away from becoming a regular citizen. He is in the home stretch. According to the Wall Street economists and Federal Reserve officials, the US economy is on firm footing and should be able to continue its winning streak into Obama’s final days as President.
Yet, I can think of at least two Presidents that seemed to be riding into the sunset with nary an economic care in the world when a market disaster hit.
The first was George W. Bush. Although Bush’s Presidency was filled with more crises than anyone wants to remember, until the fall of 2007 the economy and markets were remarkably well behaved. There was the terrible tragedy of 2001, but apart from that, the markets did not pose a problem for Bush.
This calm proved illusory. In the fall of 2007, the markets made up for all the previous benign behaviour by starting a decline that would eventually trigger the greatest economic panic since 1929.
Under the Bush Presidency, the market topped in the fall of 2007, which corresponds to approximately the current day in the Obama Presedential timeline.
You are probably saying to yourself, so what? That doesn’t mean anything. The situation was different then.
But what about Reagan? He was also a two term President whose final days looked like clear sailing. What happened during his final year?
Most economic forecasters were also predicting a calm final year for Reagan to coast into the end of his Presidency. Unfortunately we all know that was not to be.
Just because the Autumn before the final year of their term ushered in market disasters for both Bush and Reagan does not necessarily mean it will be the same for Obama. I don’t think anything is carved into stone. The analogy is interesting, but it is not some prophet proclaimed destiny.
But we would be foolish to ignore the similarities. Today we have a QE induced stock market bubble with a Federal Reserve that seems intent on normalizing policy regardless of the consequences. This is combined with a government one step away from being unable to pass legislation to get the debt ceiling raised. All the while, the global economy is sinking into a morass no one seems to be able to stop. And finally, too many of the economists that decide policy, have somehow magically convinced themselves an economic upturn is right around the corner. This is the stuff of a financial accident.
It would make sense that if we were to have a market dislocation, it would occur at a similar time in Obama’s Presidency as previous crises. I don’t think we are out of the woods by a long shot.
Yet there is still hope. If the Federal Reserve eases up on the hawkish rhetoric, and China puts the pedal down to the metal, I could easily envision the markets (and economy) blasting higher during Obama’s final year. But so far that is wishful thinking.
Even in the face of Friday’s terrible employment number, the Fed continues on with their “zero was an emergency low rate and the emergency is long past” rhetoric. They are so desperate to normalize rates, even in the face of the poor employment report, Fed Presidents see nothing but clear skies ahead:
BULLARD SAYS EXPECTS STRONGER JOBS REPORTS TO COME.
Really? Didn’t you expect stronger jobs report this time? And the last? And the one before that? Weren’t you predicting the Phillips curve would kick in and wage inflation would skate the US economy out of its slump?
Maybe the FOMC committee wants to normalize rates, but let’s give up the pretence it is because the economy is so strong.
The Fed is responsible for far more of this global slowdown than they care to admit. I don’t begrudge them if they want to normalize policy and think the short term pain is worth the long term gain. But let’s not kid ourselves that it is painless to normalize policy.
Deutsche Bank recently wrote a report that stated the unwind of QE means the S&P should be trading at half of its value (click here for Zero Hedge link). Although I am not sure I agree with all the author’s logic, the US stock market has been a direct beneficiary of QE. Therefore the withdrawal of this stimulus has to be a negative for the stock market.
No one, including the Federal Reserve, knows in advance the correct amount of QE, or how long rates should be left at zero. The private sector credit creation that is largely responsible for determining the velocity of money is simply not forecastable. However, it is easy to determine if the current monetary policy is either tight, neutral or accommodative. All you need to do is look at the market signals. They are all around you. A soaring US dollar, commodities that are collapsing, break even inflation levels that are hitting new lows, credit spreads that are blowing out – all signal the Federal Reserve is too tight.
As the Federal Reserve has finished expanding its balance sheet, and now started to prepare the markets for higher rates, the global economy has slowed. They seem to be oblivious to this fact. The economy needs more US dollar liquidity from the Central Bank than they wish to be the case. It is sad, but it is the truth. Instead of just accepting this reality and dealing with the economy they have, the Federal Reserve is making policy for the economy they want. That’s their prerogative, but don’t think it’s harmless. The longer they continue down this path, the higher the likelihood of a big financial accident.
Reagan and Bush both thought their final days in office would be clear sailing on the economic front. But instead they were both tested with two of history’s biggest market crashes. Will it be the same for Obama? No one knows for sure, but the longer the Federal Reserve committee keeps their fingers in their ears shouting “LALALALA -CAN’T HEAR YOU” while real damage is being done to the economy, the greater the chance that Obama’s last year will look like Bush’s or Reagan’s…
Thanks for reading,