Chris Ciovacco: Confidence In Stocks & Economy: Then And Now
In this weekend’s article, we tackle three major topics that may alter the way you invest:
- How the Fed impacts asset prices.
- The market does not care what you think.
- Using concepts 1 & 2 to compare 2007 and 2013.
Why Is Wall Street Obsessed With The Fed?
Before we move to the “you decide” comparisons of 2007 and 2013, it is important to acknowledge the Federal Reserve’s method for propping up asset prices. The Fed provides a difficult-to-overstate source of indirect demand for financial and physical assets. Here is basically how quantitative easing (QE) works: The Fed prints money, they give the printed money to primary dealers, the Fed gets a bond in return, and presto they have injected new money into the global financial system without having to deal with messy stimulus votes in Washington. The primary dealers (and/or their clients) can do whatever they want with the freshly printed greenbacks, including purchasing stocks, distressed real estate, or anything their hearts desire. That, my friends, is how stocks can go up when the economy is in such a tepid state and why Wall Street is obsessed with the Fed’s printing presses. If you want to do some homework over the weekend, this series of videos will allow you to enter the top 1% in terms of understanding what, why, and how the Fed does what it does.
Fed Was Tightening In 2006-2007
Many believe QE is some radically new method of stimulating the economy. QE is really no different than normal open market operations the Fed has used to adjust interest rates for decades. The only significant difference is QE takes place when interest rates are already near zero; which places QE into the pure money printing category. If you want to find one immensely important difference between Q3-Q4 2007, when the stock market peaked, and October 2013, look no further than Fed policy. In 2006 the Fed raised interest rates four times, which takes the QE process and puts it in reverse. QE sees the Fed swap cash for a bond. When the Fed was raising interest rates in 2006, they were swapping bonds for cash, meaning they were draining “liquidity” from the global financial system in 2006-2007.
2013: Instead Of Draining, The Fed Is Injecting
If we fast forward to the present day, Fed policy involves pumping billions of dollars into the financial system each month. From Bloomberg:
After flirting for months with the idea of curtailing stimulus, the Fed said in September it would continue purchasing $85 billion of bonds a month, citing the need to see more evidence that the U.S. economy will improve.
Reading The Market’s Palm
Technical analysis (TA) is the study of charts. TA often gets slumped together with voodoo and palm reading. The power of charts, and why they are used by the vast majority of pension funds, is they allow us to monitor the mechanism that sets asset prices. If you understand how assets prices are set, then the value of monitoring charts is easy to understand.
A Different Way To Approach Investing
Let’s assume we run a controlled market experiment where:
- We give 1,000 investors an annual report to read for company XYZ.
- All 1,000 are asked to read the report and then value the stock.
- Stock XYZ can only be traded or owned by these 1,000 investors.
The Market Does Not Care What You Think
If I am one of the 1,000 investors in the experiment, how relevant is my personal opinion in terms of how the price of stock XYZ is set in the marketplace? In simplified terms, my personal take on the value of XYZ impacts the price by roughly 0.10% (1/1000). Stated in a politically correct manner, 99.9% of the factors impacting the price of XYZ have nothing to do with my personal analysis, forecast, or opinion about XYZ, or the global macro environment for that matter. Said in a more direct manner, the market does not care what “I think” about where XYZ is headed or what it is worth. It sounds harsh, but that is the way markets work. Does that mean fundamentals don’t matter? Absolutely positively not; the concept simply defines how fundamentals impact asset prices.(...)Click here to continue reading the original ETFDailyNews.com article: 2007/2013: You Will Never Look At The Markets The Same Way AgainYou are viewing an abbreviated republication of ETF Daily News content. You can find full ETF Daily News articles on (www.etfdailynews.com)
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