How the Fed Burst the Everything Bubble

Apr 6, 2023 10:54:27 AM

Did you see this year's Oscar winner, Everything, Everywhere, All at Once? It featured a large, everything bagel as the black-hole villain that had to be resisted or defeated. It was wacky and weird but also rooted in a simple storyline based on changing the status quo, unconditional love, and acceptance.

The evil everything bagel in the movie can be compared to the everything bubble created by our US economy over the last 15 years. The bubble did contain everything - a housing market, a stock market, and a bond market that was all overpriced at record highs simultaneously… Everything, everywhere, all at once indeed.

Quantitative easing 

The Financial Crisis

It all started during the 2008 financial crisis. The Fed began by dropping rates but felt compelled to go further. That was when Quantitative Easing was first introduced to the American people as a short-term bandage.

To stimulate the economy, the Fed injected money into our financial systems - the plan was to put the money into banks and for them to put it back out into the world - by lending money (because, at the time, no one was lending money).

This initiative went a long way to inspire optimism, yet the experiment seemed to fail. The banks still weren’t lending money. Instead, they used QE money to invest and pay themselves hefty salaries. The banks invested in the same bonds as the Fed bought because the Fed was inflating the prices. This move did not help the American people. Instead, the banks took advantage of the situation.

Bullish sentiment

Instead of moving away from Quantitative Easing, the US government urged a double-down effort in November 2010 when business output and employment were still too low. As a result, the Fed introduced QE2 as a deliberate effort to make risk-taking more attractive. The result was what became the longest bull run in stock market history. 

Some compared it to a casino where no one ever lost. Instead, more investors got bullish on the stock market, and everything went up. The adage “Don’t fight the Fed” became common - meaning that when the Fed has an “easy money” posture, investors should own stocks and not worry too much about valuation.

The problem was that QE intended to be a short-term solution. The Fed knew this and started to introduce tapering off of buying. This caused almost immediate and extreme volatility. The markets freaked out, and the term “taper tantrum” was born.

This caused to Fed to backtrack and easing continued. Then, in 2012, when unemployment was elevated, and business investment was still too low, the Fed brought in another round with QE3.

The wealth gap

The Wealth Gap

By 2015, the US seemed to be in a time of economic recovery. But unfortunately, most of America’s middle class suffered from higher unemployment and little to no savings. The wealth gap was no longer a fissure, it was a vast canyon, and it showed in the polls as Americans voted in a new president that was remarkably anti-government and promised to “drain that swamp.”

Jerome Powell joined the Fed in 2017. He was tasked with re-introducing Quantitative Tightening, and when he did, the market tanked in December 2018. After pressure from the White House, Powell changed course and walked back the QT move, capitulating to financial markets and political pressure. The Fed was now tasked with saving the stock market.

The End of the Bull Run

By 2019, the Fed had been using QE as the status quo causing concentrated wealth and raising prices in companies that weren't even making a profit. Lower interest rates also forced companies to take on too much corporate debt.

This brought on a period of massive stock buybacks, approximately 6 trillion dollars' worth. Unfortunately, this distorted economic climate caused companies to focus only on their stock price. As a result, the Fed lowers rates, and companies borrow money and buy back stocks.

They invest in tech to eliminate workers and give their CEOs big bonuses. Then they issue more debt and buy back more stock instead of investing in and improving actual products or companies while lowering the number of people they employ.

When the world realized, in early 2020, that we were entering into a true Pandemic, panic hit. Fear caused a sell-off. People were going into cash - not even bonds or treasuries. Indicators were pointing to a potential crash, and an 11-year bull market ended abruptly.

The Bailout Continues

The Fed introduced QE4, buying up debt and making money available to banks at lowered rates. This was the most extensive economic help ever offered, at 6.2 trillion dollars - part of that amount went to the Fed, which bought corporate debt on an unprecedented scale. Most believe these actions indeed prevented a large-scale depression.

The stock markets boomed as people were out of work and unemployment was at 14.7%. The bad news was good news for the stock market, and stocks remained at record highs for two years in what many called an orgy of speculation. Unfortunately, the QE fire hose had been left on.

The bail-out continued as Biden sent stimulus money and relief programs to anyone and everyone. With too much money and excessive demand for goods that were hard to come by, inflation was sure to come. But the Fed disagreed, calling the trend “transitory” and saying it would not stick.

The Fed finally budged on QE on March 16, 2022, when the Federal Open Market Committee enacted the first of nine interest rate increases, thus bursting the everything bubble to fight inflation. 

QE In Hindsight

Looking back, it’s easy to see the cause and effect of Quantitative Easing in the US economy. Looking forward, the picture is still fuzzy. The Fed’s future moves depend on inflation, employment, and banking stress. The markets now fear that defeating inflation will tip us into a recession.  

The time has never been better to find an active manager that is more than prepared to navigate the volatility of an uncertain future. We have witnessed the defeat of an evil everything bagel, no, bubble. The effects of the end of an era of rock bottom interest rates and stocks that couldn’t lose will take some time to develop. In the meantime, the Fed seems determined to stick to the plan of walking away from QE, regardless of the pain it may cause. 

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