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Yesterday?s Fed
decision was one of the most anticipated ever, with much potential
to really change the global financial-market dynamics going
forward. But thanks to the Fed?s incredible market distortions of
recent years, Fed meetings spawning exceptional volatility is
nothing new. Fed decisions? impacts on gold and stocks have been
vast. And this next tightening cycle should reverse their
Fed-imparted directionality.
Before we get
started, a big caveat is necessary. While this essay was published
the morning after that Fed decision, I had no choice but to research
and write this draft before yesterday?s momentous 2pm event!
Producing one of these weekly essays takes a lot of time and effort,
and even after writing
670 of them there was no possible way to start this process
after the Fed and still make the publishing deadline.
That presented a
challenging quandary, as the Fed?s decision and surrounding posture
is all anyone is interested in this weekend. I?ll discuss the
specifics of everything the Fed did and said in great depth, as well
as the resulting market impact and outlook, in Tuesday?s
Zeal Speculator
weekly newsletter. But leading into that hyper-anticipated event, I
wanted to do some background research on the Fed?s market impact.
The elite group
within the Federal Reserve that actually makes the monetary-policy
decisions is the Federal Open Market Committee. The FOMC includes
ten voting members, and is led by the Fed Chair Janet Yellen
herself. Four other members are from the Fed?s Board of Governors,
while the remaining five are regional Fed presidents. The New York
Fed has a permanent seat, while the four others rotate annually.
No other ten men
and women in the world wield such enormous power over the fortunes
of economies and markets, which is why investors and speculators
are forced to so closely follow the Fed. The FOMC meets 8 times
per year for monetary-policy-setting purposes, about every 6 weeks
or so. These meetings usually wrap up on Wednesdays with a
statement outlining their decision published at 2pm New York time.
Every other
meeting is followed by a press conference by the chairman. The FOMC
usually saves major policy changes for that half of its meetings,
since they give it an opportunity to explain its actions and calm
down traders. The press-conference-followed meetings also include a
summary of the economic and interest-rate projections of the ten
FOMC members as well as the remaining regional Fed presidents.
As a lifelong
speculator and student of the markets, I anticipate Fed days with
great interest and dread. Volatility is what makes the
markets fascinating and tradable, and the FOMC spawns big market
moves in spades. But the anxiety comes from volatility being a
sharp double-edged sword. When you get stuck on the wrong side of a
trade after an FOMC decision, it?s certainly painful to weather the
resulting tumult.
As I?ve thought
intently about yesterday?s epic Fed decision in recent weeks, I
wanted to gain a better grasp of the outsized impact of
recent years? FOMC decisions on the two main markets I trade. They
are gold and the stock markets. So this week I went through and
analyzed the gold and stock-market action as represented by the
flagship S&P 500 stock index immediately after ever FOMC decision
since early 2013.
I certainly
remember many volatile Fed days and their immediate aftermaths, but
I was surprised at just how ubiquitous extreme FOMC-sparked
volatility has been! Starting at every 2pm FOMC decision, I looked
at those trading days and the couple immediately following. In both
gold and the stock markets, any single-day or several-day move
beyond 1% is noteworthy. So I analyzed all net moves exceeding
that.
Amazingly I found
the results a bit shocking. Since I trade and write newsletters for
a living, I am very blessed to watch the markets all day every day.
So I not only lived through all 21 FOMC decisions since early 2013
in real-time, but I wrote about them extensively in our following
weekly and monthly newsletters. So I remember all kinds of
Fed-spawned volatility, but all those Fed days blend together to
mask their magnitude.
This first chart
looks at the SPX and gold since early 2013. That date is important
because that?s when the Fed?s wildly-unprecedented open-ended
third quantitative-easing campaign ramped up to full speed. QE3 has
radically distorted global markets, spawning an
extraordinary
stock-market levitation that all but
obliterated
demand for alternative investments led by gold. The Fed has
utterly dominated recent years.
The FOMC?s
decisions, along with the associated Fed-official jawboning and
resulting psychology among traders, have been the
overwhelmingly-dominant driver of gold and stock markets since
early 2013. The Fed?s actions eclipse all secondary drivers
combined by an order of magnitude, they are truly the entire market
story since early 2013. There?s never been another market era where
the Fed had more influence!
So every FOMC
decision in this surreal span is marked with a yellow line. And
starting the trading day of each 2pm FOMC-statement release, and
continuing for the following two trading days, any outsized
reactions above 1% net are noted in gold and the SPX. Once again
even after experiencing all of these events at a deep professional
level, I was surprised at their potency and consistency considered
as a whole.
The outsized gold
and stock-market reactions immediately following FOMC meetings were
so common that this chart got busier than I expected. Let?s start
on the stock-market side since the Fed?s QE3-driven stock-market
levitation has dominated sentiment in all markets. Of the 21 FOMC
meetings before this week?s since early 2013, fully 13 or 62%
saw outsized stock-market reactions as seen in the benchmark SPX.
And a whopping 10
or 77% of these were positive, with the SPX rallying on the Fed day,
the Fed day and the subsequent trading day, or the Fed day and the
next two trading days. The average gain after an FOMC decision on
these upside reactions was 1.6% within several trading days
including the Fed day. This further illustrates how the Fed has
bent over backwards to appease stock traders since early 2013.
The SPX
experienced two massive reactions to FOMC days in recent years,
which I define as monster 3%+ moves off an FOMC decision within that
3-trading-day span including the Fed day. The first was a huge 3.9%
loss the stock markets suffered after the FOMC?s mid-June-2013
meeting. While the Fed didn?t act that day, Ben Bernanke chose his
post-meeting press conference to drop a bombshell on the markets.
That day he simply
laid out a best-case scenario, a hypothetical timeline, of
when the Fed might start to taper its QE3 bond-monetization
purchases later that year. The resulting violent downward reaction
of the stock markets on the mere hint of less-aggressive extreme Fed
easing is a damning indictment of the artificial nature of stock
markets? QE3-driven rally. Without the Fed, recent years? surge
never would?ve happened!
The second massive
reaction of the stock markets to an FOMC decision came with the
SPX?s colossal 4.5% gain after the mid-December 2014 meeting.
Provocatively that wasn?t a highly-anticipated Fed day, with the
FOMC expected to do nothing but remove two words from its
statement. It had promised a ?considerable time? between the end of
QE3?s bond buying and the first interest rate hike since June 2006.
But when the FOMC
released its statement with the dovish ?considerable time? still in
there, computers parsed it instantly and went on a bidding frenzy.
That day and the next, the SPX rocketed 4.5% higher on traders? view
that the Fed was still backstopping the stock markets! The
FOMC was afraid of rocking the boat with the stock markets so lofty,
and traders took advantage of this to recklessly flood back into
stocks.
Both statistically
and visually in this chart, there?s no doubt that FOMC meetings
during recent years? period of the most-extraordinary easing in the
Fed?s history have proved very bullish for stock markets.
The SPX not only surged in an outsized fashion far more often than
not after FOMC decisions, but it often climbed to major new secular
highs soon after the Fed spoke. The Fed literally levitated
the stock markets!
This
overwhelmingly-upside SPX behavior during the latest years of the
Fed?s extreme easing has very ominous implications for the Fed?s
first tightening cycle in over 9 years. If the uber-dovish
FOMC decisions and jawboning in recent years was so darned bullish
for stocks, odds are stellar that the Fed starting to unwind its
record easing is going to be bearish. Indeed higher rates
hurt stock markets in a variety of ways.
Directly they make
yields on new bonds relatively more attractive, enticing investors
back out of dividend-paying stocks into bonds. This puts lots of
selling pressure on stock markets. But higher rates have a big
indirect impact too. They slow the overall US economy by raising
debt-service costs, weighing on national consumption which soon
translates into lower corporate sales and profits. That?s a
big problem.
Lower earnings
make
already-overvalued stock markets look even more expensive,
catalyzing more selling. So just as the most-easy Fed ever seen
provided a monumental tailwind for the stock markets in recent
years, a new tightening cycle shifts that to a major stock
headwind. Investors and speculators alike need to realize a
Fed-levitated stock market won?t fare well as the punch bowl is
finally taken away.
As the only major
asset class that generally moves contrary to stock markets,
gold suffered the opposite fate in the Fed?s record
zero-interest-rate-policy-and-quantitative-easing-fueled market
anomaly of recent years. With the Fed choosing to effectively
backstop stock markets, investors pulled vast sums out of other
assets to deploy into the strong stocks. Gold was the major
casualty of this mass exodus.
The FOMC meetings?
impact on gold in recent years was vastly greater than their impact
on stocks. Gold saw outsized moves immediately after fully 16 of
the 21 FOMC meetings before this week?s, or 76%! And the impact
was overwhelmingly bearish and negative, with 12 of those 16
meetings seeing losses over 1% in the immediate aftermath of FOMC
decisions. And gold?s losses far exceeded the SPX?s gains.
Gold plunged 2.6%
on average on the Fed day, the Fed day and the subsequent trading
day, or the Fed day and the next couple trading days! That?s a
really big move. And an amazing 6 of these 16 episodes where gold
reacted strongly right after FOMC decisions exceeded that 3%
threshold necessary to qualify as massive moves. The biggest one
was gold?s astounding 6.4% two-trading-day plunge in June 2013.
Once again that
was that same FOMC meeting followed by Bernanke?s press conference
where he very carefully laid out the possibility that the Fed would
start reducing the size of its mammoth monthly bond monetizations.
The prospect of less monetary inflation led gold to promptly
collapse. Before that fateful Fed-conjured distortion changed
everything, gold had held strong around $1375 to $1425 for a couple
months.
Gold had suffered
a panic-grade
selloff back in mid-April that year after a major secular
support zone failed. Gold sentiment was damaged, but
psychologically traders could?ve rebounded from a single extreme
selling event. But the subsequent plunge on that June-2013
QE3-taper-scare FOMC meeting drove the final nail into the coffin of
gold sentiment. It was that Fed event that led gold to become hated
to this very day.
The really sad
part was that reaction was ridiculously absurd! The FOMC
first announced QE3 back at its mid-September-2012 meeting, and
subsequently expanded it to full steam shortly later at that year?s
December meeting. Gold shot up 1.9% the day of that first meeting
to $1766 on the Fed promising to create more money out of thin air
to buy bonds, pure inflation. And after the second, it was
still way up at $1712.
The day before
that June-2013 QE3-taper-scare meeting, gold was at $1368. So not
only had this metal not rallied at all during QE3, it had fallen 23%
over that timeframe where the Fed?s balance sheet had ballooned from
$2779b to $3418b. Gold had paradoxically lost 23% over the same
short span where the Fed?s inflation had grown its balance sheet
23%! If gold didn?t rally in QE3, why should it reverse on
QE3 ending?
Anyway, the
overall impact on gold during the Fed?s extraordinary easing of
recent years was powerfully negative. Even though
record-low
interest rates and currency created out of thin air to monetize
bonds are super-bullish for gold historically all over the world,
gold was crushed by FOMC dovishness in the last few years. Why?
The Fed was actively enticing money out of everything else to chase
levitating stocks.
So just as a
tightening cycle is going to reverse the Fed?s massive upside impact
in stock markets, it is also going to reverse the Fed?s massive
downside impact in gold. Today with gold bearishness universal,
traders all assume the next Fed tightening cycle is going to doom
gold. Gold yields nothing, so higher rates leave it far less
competitive. The problem is market history thoroughly refutes
this popular argument.
A couple weeks
ago, I published the results of
my comprehensive
study on how gold fared in every Fed-rate-hike cycle since
1971. It not only rallied through 6 of those 11 cycles,
performing better the bigger and longer the rate-hike cycle, but saw
massive average gains of 61% in these exact Fed-rate-hike cycle
spans! Gold soared 50% higher during the Fed?s last rate-hike cycle
between June 2004 and June 2006.
Even though the
Fed more than quintupled its federal-funds rate from 1.00% to
5.25% over that span, making bond yields far more attractive, gold
surged. Why? Because higher rates really damage stocks and
existing bonds, renewing investors? demand for prudent portfolio
diversification through gold. Fed-rate-hike cycles have proven
very bullish for gold historically, especially when gold is low
going into one.
And no matter what
Yellen said yesterday, the initial rate hike is merely the first
step on the long road to normalization. This last chart
looks at the Fed?s balance sheet and federal-funds rate over the
past 35 years or so. The
full
normalization of the Fed?s extreme zero-interest-rate policy and
quantitative-easing campaigns is going to take many years, it?s not
a trivial little one-hike-and-done scenario like widely hoped.
The epic
once-in-a-century stock panic in 2008, the first in the Federal
Reserve?s entire history, changed everything. The Fed panicked,
implementing both ZIRP and QE. In the 25 years before that panic,
the federal-funds rate averaged 5.5%. Returning to there is what a
full normalization entails on the rate side. At a quarter point per
hike, it would take 22 rate hikes to restore the FFR to its
modern historical norms!
And that?s not
impossible or even improbable. Between June 2004 and June 2006, the
Fed hiked by a quarter point 17 FOMC meetings in a row to
bring the FFR back near its historical average. So don?t take this
one-and-done nonsense seriously, a rate-hike cycle is not a
one-time event. And the Fed hasn?t even started unwinding its
gargantuan bond purchases yet, as its exploding balance sheet
indicates!
If the Fed hadn?t
panicked and implemented QE in response to that stock panic after
ZIRP burned all its conventional monetary-policy ammunition, a
normal growth trajectory would have taken the Fed?s balance sheet up
near $1.2t today. Yet thanks to QE it?s a staggering $4.4t! So the
Fed somehow has to sell, or more likely roll off, $3.2t in bonds
before we will know how this extreme monetary experiment turned out.
Make no mistake
friends, the fat lady hasn?t sung on the extreme Fed policies since
late 2008 until rates and the Fed?s balance sheet are fully
normalized! The ultimate impact of both ZIRP and QE in both the
markets and economies won?t be known until they are fully unwound.
So no matter what gold and the stock markets are doing in the
immediate aftermath of this latest FOMC decision, it?s only the
tiniest start.
Since this
extraordinary Fed-easing era was so friendly to stocks and hostile
to gold, its unwinding is almost certain to bring about the exact
opposite outcome. Rising rates, and the threat of more rate
hikes for years to come, will weigh on lofty overvalued
Fed-levitated stock markets. And as stock markets suffer, capital
will return to gold. Investors and speculators ought to sell stocks
and buy gold to ride this.
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The bottom line is
FOMC decisions have had vast impacts on both gold and stock markets
in recent years, yesterday?s was nothing new. The Fed?s
wildly-unprecedented zero-interest-rate policy and
quantitative-easing debt-monetization campaigns provided a powerful
tailwind for stocks, fueling an extraordinary stock-market
levitation. FOMC decisions tended to reinforce this bullish
Fed-conjured upside bias.
Conversely gold
was beaten to a pulp as the Fed seduced investors into forgetting
prudent portfolio diversification. With the Fed shifting from
record easing to a years-long tightening cycle, the fortunes of the
markets are due to reverse. The stock markets are going to face a
stiff headwind for years, forcing investors to diversify back into
alternative investments led by gold. Is your portfolio ready for
this monumental shift?
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