Bulls Buy Stocks, As Fed Starts Talk Of Taper

“The correlation between the Fed’s monetary interventions and the stock market is evident. The increase in the Fed’s balance sheet remains in near lockstep with the stock market’s climb.”

Of course, you should also not the period of somewhat volatile and ZERO return from 2018 through March 2020, as the Fed tapered their balance sheet.

The Fed currently purchases $120 billion a month in Treasury and Mortgage Back securities, which has inflated both an equity and housing bubble. However, given the rapid economic recovery and rising inflationary pressures, the Fed is now setting the table for the “T” word. The following are two excerpts from the recent Fed minutes.

“A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”

Such is important because they also realize they are responsible for elevated asset valuations.

“Regarding asset valuations, several participants noted that risk appetite in capital markets was elevated, as equity valuations had risen further, IPO activity remained high, and risk spreads on corporate bonds were at the bottom of their historical distribution.”

Let’s focus on the last sentence.

Risk Is Elevated

The most considerable risk to the “equity markets” is always a “credit-related event.” When credit stops flowing, for any reason, the resulting liquidation spreads across every market as the scramble for safety begins.

Mish Shedlock had an excellent note out on this issue this week.

“‘When I look at CCC’s rallying so hard — even if the default rates are at the low end of historical average — your chances of making money over the long run aren’t great. You’d be lucky to break even.’ – John Hussman”

Of course, CCC-rated bonds are just one step above bonds that are already in default. Yet, as Mike notes, there is “no fear” of default from bonds that historically have a very high propensity to default.

With the Fed likely on the verge of tapering, interest rates rising, and economic growth slowing later in the year, the risk of a credit-related event has increased markedly. While the media is busy focusing on “inflation,” which “will be transitory,” the credit market is the “monster under the bed.

“I do believe fear is on the horizon. But it is not fear of inflation. Rather it is fear of paying too much for junk bonds, too much for stocks, and too much for cryptos, most of the latter will be worthless.

Writers, no doubt, will blame it on fear of inflation. That’s the excuse of the day instead of blaming the Fed with help from Congress for another huge set of bubbles.” – Mish Shedlock

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