Ian King has noticed that he is hearing a familiar story these days. It seems that the Federal Reserve has been up to its old tricks during this rate-hike cycle, but the rate-hike hasn’t created the results that were expected. In other words, the market is not reacting to it, and Mr. King isn’t surprised.
Ian King is the perfect person to comment on this subject because he has several years of experience in the financial industry, and he is well aware of all of the trends that present themselves in the markets. He spent two decades as a hedge fund manager and is currently a cryptocurrency trader. He has been analyzing the financial markets over the years, and he can be considered to be an expert. Others agree with this assessment because he has been invited to contribute content to Investopedia, Zero Hedge, Seeking Alpha and Fox Business News.
Investors are concerned that Fed Chair Jerome Powell has plans to prevent the stock market from continuing to go up by raising the fed funds rate. The fed funds rate is known as “the cost of money,” and it is the rate that banks charge other banks to lend them money.
Interest rates have been known to influence the economy because they determine how people and businesses decide how they will spend their money. The prices of stocks and bonds are similarly affected. Consumers and businesses tend to save more money and make fewer purchases when interest rates are higher, and this causes economic growth to slow down.
How Rate-Hike Cycles Affected Stock Prices in the Past
In the early 1990s, the feds reduced the fed funds rate to 3 percent. In the late 1980s, the rate had been set at 10 percent, and the bulls began to run. Investors gained more than 800 percent over three decades, but while George W. Bush was in office, the country was experiencing a deep recession. As Fed Chairman Alan Greenspan reduced the rates, he was hoping that the economy would start to grow again.
Mr. Greenspan kept rates around 5 percent from 1995 to 2000, and the S&P reacted by tripling its gains. Although Alan Greenspan warned Americans that an “irrational exuberance” was taking place, he kept rates at their current levels for five years.
The fact was that the economy was overheating, and Mr. Greenspan saw that it was necessary to slow it down by raising the rate by 50 basis points.
This reaction may have been too much for that time because the stock market experienced a sell-off of dot.com stocks. The market lost half of its value and remained at that point for the next two years.
The Subprime Crisis
In 2003, the Fed decided not to raise rates because the belief was that a rate-hike could trigger another sell-off. This meant that money was easy to get, and it caused home and stock prices to rise and create a bubble from 2004 to 2006. Between those years, the Fed decided that it was time raise rates to 5.25 percent. After that, Ben Bernanke stepped into the picture.
In 2007, Mr. Bernanke made a prediction that “the effect of the troubles in the subprime sector…will be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”
Just one month later, the Fed did lower rates after Bear Stearns found it necessary to bail out two subprime mortgage funds.
At that time, the S&P had confidence in Bernanke, so it continued to climb to its 2000 high, and it reached it in 2007. Later that year, the market began to fall and continued to drop in the next year until it had lost half of its value.
In 2009, the Fed reduced rates to 0 percent. This rate goes by the name of “zero lower bound” or ZLB and free money and quantitative easing followed.
During this period, the Fed began to purchase corporate bonds, mortgages and longer-dated Treasuries. The Fed did this to encourage investors to look for more “yield” or take greater risks. As they did this, they hoped that bonds, stocks and housing prices would re-inflate.
Over the past 10 years, inflation has been mild while the economy continued to grow at 2 percent, but investors purchased stocks anyway, and the S&P 500 is currently overvalued. Since 2009, the S&P 500 has increased by about 400 percent, and investors aren’t worried because the Fed is on the job.
With this complacency, Ian King believes that now is the time to be concerned about stocks.
It was at the end of 2014 when the Fed last performed quantitative easing. Currently, the Fed’s assets amount to $4.5 trillion, and rates are going up. The new fed funds target is 1.62 percent, and two rate-hikes are expected this year.
The Fed has plans to unload its assets, but it believes that it can do it so that the market will continue to keep climbing. Common sense tells us that stock prices will go down as stocks begin to be sold, but the Fed is assuring investors that this will not happen this time.
Because the Fed has discussed extensively what is about to occur, it is expected that the unwinding of assets will be discounted in the market. Therefore, the market will not experience any reaction at all. Secondly, this unwinding is expected to go on for several years, so it couldn’t possibly have any impact on the market. Thirdly, the market is no longer being driven by the Fed. Instead, the market is currently earnings-driven.
What Happened in the Past?
Ian King reminds us that the rate-hike cycle of 2000 and the rate-hike cycle of 2004 to 2006 both caused the S&P to correct itself by 50 percent.
The fact is that it’s very possible that something could go wrong. The Fed is in control of short-term interest rates but do not have as much control over the long-term interest rates. The thing that investors need to be concerned about is the time when the Fed starts to liquidate its assets. When it does this, it could very well lose control of long-term interest rates.
“History doesn’t repeat itself, but it does rhyme.” – Mark Twainhttps://t.co/z0l1it2T2a#Cryptocurrency #Currency #Crypto #Bitcoin #Ethereum #Litecoin #Blockchain #Economy #Entrepreneur #InternalAnalyst #BanyanHillPublishing
— Ian King (@IanKingGuru) April 5, 2018
The Effect of Low Interest Rates
Investors are only paying attention to rising earnings, but the point is that earnings are rising because of low interest rates. Corporations can now borrow money at the lowest interest rates. Low interest rates are encouraging the liquidity that is driving global growth. It has been easier for companies to borrow money that allows them to purchase their own stock, so their earnings per share are increasing. All three of these factors are driven by low interest rates, and these are facts that investors are ignoring.
Now, it is possible that a trade war is about to start, and the market is overvalued. Ian King is wondering why a rate-hike wouldn’t cause the same thing to happen now that happened the last two times.