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Is the Fed Building Another Stock Bubble?


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Is the Federal Reserve letting the stock market party like it’s 1999?

Several savvy observers see similarities between shares’ recent levitation on the heels of the central bank’s aggressive provision of liquidity to calm the repurchase-agreement market and the days when it pumped in billions to stave off the looming specter of Y2K and, in the process, inflated the dot-com bubble.

Of course, the modern world didn’t come crashing down when the calendar flipped from 1999 to 2000. But just in case the Cassandras might be right, the Fed supplied about $120 billion to the market through repos to prevent any financial disruptions. That figure was on par with what the central bank pumped in during the financial crisis in 2008 and significantly more than it provided in reaction to the Sept. 11 attacks, according to Jim Bianco, the eponymous head of Bianco Research.

In 1999, there was certainly circumstantial evidence of the Y2K funding’s impact on stocks, writes Julian Brigden, chief economist at Macro Intelligence 2 Partners. “Immediately following the Fed’s launch of its special fund facilities, the equity market accelerated higher,” he notes. At the time, the biggest momentum play, the Nasdaq Composite777彩票地址, already was up 100% from its level a year earlier. When the Fed started boosting liquidity, the tech-led index went parabolic, he observes.

This time, the Fed has expanded its balance sheet by $400 billion in four months—a $1.2 trillion annual clip, according to Evercore ISI. 777彩票地址 “have gone on a tear” since the bank announced on Oct. 11 that it would begin buying Treasury bills. The timing of the move was similar to 1999’s, but the magnitude was more modest, Bianco notes.

777彩票地址As they were two decades ago, momentum stocks appear to be the most obvious winners, MI2’s Brigden observes. “To some extent, this precisely is as it should be, because the Fed is not trying to pick winners,” he writes. “That’s the market’s job. The Fed is just there to keep the party going. And they do seem to have been successful.”

Exhibit A is Apple (ticker: AAPL), which he noted “has surged 38% since the Fed’s repo program started and is now breaking out of a well-established channel” on a price chart stretching back to 2015. “Another potential winner is Tesla (TSLA), where the Fed’s intervention may have helped resolve a multiyear battle between bulls and bears by encouraging short covering.”

To be sure, “there is no such thing as a one-factor model to explain the stock market,” Bianco writes. “Metrics such as the Fed’s balance sheet, repo, etc., cannot explain the stock market’s movements in isolation.

777彩票地址“That said, when the Fed injects money, funds generally flow to the best-returning market. During the financial crisis, it was the bond market. Today, as was the case in 1999, it is the stock market.”

Moreover, as the Fed has been spiking the punch bowl to avert any bank funding problems, investors’ mood has been ebullient. CNN’s Fear & Greed Index hit a euphoric high of 97, a recent peak, on Thursday. After news of the U.S. strike to kill the powerful Iranian military leader Qassem Soleimani, stocks on Friday fell only fractionally, as initial sharp overnight losses in S&P 500 futures were pared by about a third. edged down only slightly.

Oil prices rose, but oil shares tracked by the Energy Select Sector SPDR exchange-traded fund (XLE) dipped slightly. Even the Cboe Volatility Index, or VIX, the market’s fear gauge, couldn’t manage to climb above 16, despite the potential for an escalation in the conflict between the U.S. and Iran. That indicates that Fed liquidity can dampen volatility.

But what happens if Powell & Co. stop supporting the repo market? History isn’t encouraging. Bianco points out that the Nasdaq crashed 25% from April 7 to April 14, 2000, the week during which the Fed’s Y2K facility closed.

Brigden sees four scenarios for the Fed’s current liquidity operation:

777彩票地址The monetary authorities could let the repo program wind down once they think that risks have subsided. Or they could keep it and maintain flexibility, perhaps charging a penalty interest rate to tap it. Either course would essentially make the market end its liquidity fix cold turkey, risking a “2000-style carnage,” he says, making those options less likely.

777彩票地址Alternatively, the Fed could hold its balance sheet steady. Or it could keep ramping up liquidity, providing the market with “the opportunity to engage in an orgy of leverage. Until the bubble pops,” Brigden concludes. Meanwhile, party on.

Write to Randall W. Forsyth at randall.forsyth@barrons.com


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