If you’ve been following financial markets recently, you may need to see a chiropractor for the inevitable case of whiplash you’re experiencing. The benchmark U.S. equity index, the S&P 500, fell by over 8% before rallying over 7%, all within the last five trading days. These are monumental moves for an index that often doesn’t see such pronounced changes in an entire year, let alone a week. What’s going on, and why should you care?
Textbook finance flew out the window months ago. Invest in bonds when you believe the yield is enough to justify the risk? Invest in equities with good cash flows or positive growth? Not anymore. Will the central bank keep buying bonds? Will bondholders who just sold to the Federal Reserve and are now flush with cash invest in equities? Will firms buy back their own stocks? These are the questions you need to be asking because they are what will predict financial markets in the near term.
Since March, the Fed, Bank of Japan and European Central Bank have bought over $5 trillion in securities. To put that into perspective, in the 15 years prior, including the Great Recession of 2008, these three central banks spent less than $10 trillion in total. Initially, the Fed only bought bonds indirectly through exchange-traded funds (ETFs) whereas now they are buying bonds on the secondary market. This doesn’t help the corporations selling them; it helps the holders of these bonds that purchased them from the corporations that issued them. In other words, this is a massive bailout for the rich. The Bank of Japan now owns nearly 6% of publicly traded firms in Japan. The Europeans are all bailing out firms integral to their economies. The Fed is on a shopping spree.
Market economies? Laissez-faire and the invisible hand? These are all antiquated terms that exist only in textbooks. Adam Smith may be rolling over in his grave as widespread nationalization of financial markets has taken hold. So, how to trade these moves? Always bet on the wealthy. The rich will lobby governments to bail them out, so I doubt markets will collapse. Once in a while, however, investors will get jittery when they hear the worst isn’t over and try to cash out. This will be followed by pro-recovery news from governments and the financial press they exist in a symbiotic relationship with – which will cause more rallies. Should markets be rallying? No. Are markets rallying? Yes. Ignore fundamentals, and don’t bet against the Fed. Invest with a long-term time horizon, and you should do well even if real economies don’t – that is, of course, if you can stomach the roller coaster ride it’s going to be.
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