Parallels To The Dotcom Bust - Bubbles Everywhere
Wolf Richter is one of my many favorite sources of information. His comments are always worth reading, and brings the reader’s attention right to the point.
The Dow Jones Industrial Average on Friday closed about 300 points below its June 16 low, thereby having more than wiped out the bear-market rally gains. For the Dow, the bear-market rally started on June 17 and ended on August 16. During the two-month rally, the Dow had jumped 14%. By Friday at the close, it was again down 20% from its all-time high.
The S&P 500 Index, on Friday intraday, fell through its closing low of June 16 – the infamous 3,666 – and then bounced a little to close 27 points above the June 16 low, at 3,693. During the two-month bear-market rally through August 16, the index had surged 17%. By Friday, the index was down 23% from its all-time high.
The Nasdaq closed about 2% above its June low. During the two-month rally, it had soared by 23%. Many stocks that are now trading for a few bucks, had shot up by 50% or more, and a bunch of them doubled, before re-imploding after mid-August.
The bear-market rally happened even as the Fed had already embarked on the most aggressive tightening cycle in decades, and had started quantitative tightening, meaning shedding Treasury securities and mortgage-backed securities.
The Fed-pivot fantasy did it.
The bear-market rally happened because markets – meaning folks and algorithm playing in them – had this fabulous reaction to the Fed’s aggressive rate-hike scenario: They began fantasizing about a Fed “pivot” and about rate cuts and some even about QE all over again. Asset prices began to jump and yields began to fall.
That two-month bear-market rally in the summer of 2000 suckered a lot of people back into the market, thinking that stocks are going to the moon again, and they got crushed.
So we got a huge two-month rally, and the Fed-pivot mongers, including the hedge funds, that got out in time made a huge amount of money. But those people that believed the pivot fantasy and bought when the pivot-mongers sold, well, those folks took the losses. But that’s how it always goes.
The dotcom-bust parallel shapes up.
The bear-market rally continued, and I warned that the Markets Are Fighting the Fed, and that fighting the Fed would only cause the Fed to be more aggressive in getting its message across to the markets because it relied on the markets to transmit its monetary policies via the financial conditions to the actual economy and to demand, and that the Fed would eventually win this fight.
The simple fact is this: a Fed-inflated Everything Bubble.
Since 2008, the Fed has inflated asset prices with interest-rate repression and QE, huge amounts of QE. It caused the greatest asset bubble ever – the Everything Bubble.
In early October 2018, markets began to tank. By November, mortgage rates hit 5%, and the housing market started wheezing. By Christmas 2018, the S&P 500 Index was down 20%. Even that small and slowly phased-in QT and little-bitty 25-basis-point rate hikes – just four of them in 2018, to only 2.5% at the top end of the target range – had a big effect on these artificially inflated markets.
The Huge Difference Between 2018 and Now - Inflation
In 2018, inflation was at or below the Fed’s target, and the Fed was just trying to “normalize” policy, and it was just trying to bring its balance sheet down to a manageable level. It just wanted to get back to some kind of “neutral.” Nevertheless, Powell came under withering pressure from Trump, who’d taken ownership of the Dow. And with inflation below the Fed’s target, and with the Dow in free-fall, and with Trump keelhauling Powell on a daily basis, the Fed did its infamous pivot, and markets soared again.
The lesson is this: These artificially inflated markets cannot even maintain their level amid rate hikes and QT. Even tiny rate hikes, just four in a year, and small amounts of QT caused markets to tank, just like interest rate repression and QE had caused them to soar. It was becoming clear to everyone: QT was having the opposite effect of QE.
But in 2022, inflation has spiked above 8%, highest in 40 years, and has spread across the economy and is now spiking in services, away from supply chains and commodities, even as some goods inflation has started to unwind. And there isn’t going to be a Fed-pivot until this inflation is making “compelling” progress, as the Fed calls it, in heading back to 2%, which could be a long way off. - Wolf Street
