THE FED IS HITTING THE WRONG TARGETS.
syharding.com
While there?s a great debate going on as to whether the 1990s bull market has ended or not, the bulls and bears do agree on one thing. Federal Reserve policy will most likely determine the outcome.
The concern on both sides is that rising interest rates have killed more bull markets than any other single event, and Fed Chairman Alan Greenspan has made it clear that the Fed, which has already raised rates four times since last June, will continue hiking rates until it has slowed the economy enough to prevent an inflationary spiral from getting underway. So far the economy has shown no signs of slowing in response to the first four hikes, so another is expected from the Fed?s next FOMC meeting on March 21.
Both bulls and bears worry that rising interest rates take so long to filter into the economy that by the time the economy is seen to be slowing, the latest hikes are still in the pipeline and have yet to have their impact, resulting in the economy slowing too much, right into recession.
So, the stock market, always looking ahead to what conditions might be in place down the road, has already begun to worry about that possibility, with the Dow down 12% year-to-date.
The Fed?s decision to continue raising interest rates without first using some of its other tools is puzzling.
Fed Chairman Greenspan has repeatedly pointed to unusually strong consumer spending as the driving force in this economic boom, and credits the ?wealth effect? of the rising stock market for producing much of that consumer confidence. Backed by easy stock market profits they expect will continue unabated, consumers are more than willing to spend, spend, spend.
At first glance it would seem the Fed?s intention to raise interest rates until the pain threshold is reached, and consumers slow their spending, should work to slow the economy.
But, this time around that pain threshold may be much higher than the Fed anticipates. Main Street Joe is unlikely to put off buying that new car, and Mrs. Joe is unlikely to forego the new drapes, just because interest rates are 1% higher per year, when they just made 10% in a week on their Yahoo or Amazon stock. In the stock market, speculators aren?t fazed at paying 1% or 2% more for margin debt when they expect to make 20% in a week on the hot biotech stocks they?re buying with that margin debt.
So, while Greenspan targets consumer spending, and indirectly the bubble in the stock market, by raising interest rates, it?s having no effect on either. The economy shows no signs of slowing, and the dangerous bubble in the NASDAQ becomes even more extreme.
But the higher interest rates are having an effect on unintended targets, like the already battered ?old economy? and value stocks. Of the 115 industry groups in the economy, an astonishing 97 (84%) are down for the year already. And those losers include the banking sector, healthcare, drug stocks, transportation stocks, utilities, retailers, etc., all very important to the overall economy and all affected by rising rates.
It?s puzzling that the Fed sticks with the rate policy when it has a much better weapon that would target the intended victim with pinpoint accuracy. That weapon is its control of margin requirements (the amount of down payment speculators and traders must make to buy stocks).
In the 1920s, stocks could be purchased on margin of just 10%, which was blamed for much of the wild ride up in the stock market in the 1920s, and the subsequent crash. On the way up just $10,000 would buy $100,000 worth of stock. But when the top came, just a 10% decline wiped out the entire portfolio.
Since 1945 margin requirements have varied between 50% and 100%, currently set at 50%.
Obviously, even 50% margin can add considerable hot air to a bubble in which investors become overly optimistic and willing to buy stocks at any price on credit.
At the market peak in 1987, just before the 1987 crash, speculation had driven margin debt to a record $42 billion. Just before the 1990 bear market, it reached a high of $38 billion.
But the unusual bull market of the last five years has produced such speculative fever that margin debt is now in excess of $225 billion and growing at a rapid pace.
Instead of raising interest rates further, hitting the wrong targets, the Fed should simply raise margin requirements. By doing so it would target the actual bubble in the stock market; the one hundred or so extremely overpriced hi-tech, internet, and biotech stocks, which account for much of the margin debt, the day-traders and other short term speculators who primarily use margin debt to push those stocks up, and the image of a still strong stock market that creates much of the false wealth effect for consumers that the Fed worries about.
The result should be a cooling off of consumer spending, and the desired slowing of the economy. Yet, it would have much less risk of creating a recession than targeting the entire economy with a continuing stream of interest rate hikes. And it would go a long way toward letting some of the air out of the dangerous bubble in the hi-tech, internet, and biotech stocks without necessarily busting the rest of the stock market, in which there is not a bubble.
Just a thought. |
