The Biggest Threat To The Market – Loss Of Confidence

Yesterday, saw a record surge in the markets.

Such was not surprising given the extreme oversold condition in the market. More importantly, throughout market history, the biggest bull rallies have occurred during bear markets.

Yesterday’s relief rally was simply that.

As shown in the chart below, following the breakdown of the market from its consolidation pattern in October and November, the market plunged 20% from its previous all-time highs. Despite the massive surge in stocks yesterday, all the market managed to do was recoup 2-days of losses.

From the previous peak in early December, the market has yet to even achieve a 38.2% retracement of that decline. It would not be surprising to see this rally try and recoup a full 61.8% of the decline over the next several weeks.

However, that may not even be enough to solve the biggest risk to the market currently. 

In 2010, as Ben Bernanke was preparing to unleash the second round of “Quantitative Easing” upon the economy, he noted specifically the goal was to increase the “wealth effect” in order to assist the nascent economic recovery that was underway.

What exactly does that mean?

“The wealth effect is a theory suggesting that when the value of equity portfolios are on the rise because of accelerating stock prices, individuals feel more comfortable and confident about their wealth, which will cause them to spend more.” – Investopedia

This targeting of the “wealth effect” became known as the Fed’s “Third Mandate” which remains alive and well today as recently noted by Bill Dudley during a speech at the BIS Annual General Meeting:

“As I see it, financial conditions are a key transmission channel of monetary policy because they affect households’ and firms’ saving and investment plans and thus influence economic activity and the economic outlook.” 

Over the last decade, successive rounds of both monetary and fiscal policy in the U.S. has created an inflation of asset prices to historic levels.

The problem, as I have shown previously, is that it failed to translate across the broader economic spectrum as intended. Instead, it simply boosted the wealth of the wealthiest 10% of Americans.

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Disclosure: The information contained in this article should not be construed as financial or investment advice on any subject matter. Real Investment Advice is expressly disclaims all liability ...

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