Last week witnessed a notable turn of events. The Federal Reserve announced the end of its quantitative easing program, and surprisingly, stock prices surged. This paradoxical reaction can be considered an example of cognitive dissonance.
Before delving deeper into this anomaly, let’s briefly examine other significant events from last week. First, the dollar strengthened while commodity prices plummeted. This price movement aligns with the typical inverse relationship between commodities and the dollar.
This relationship was clearly reflected in the prices of oil and gold. Oil fell below $80 per barrel, while gold dropped to $1,172 per ounce. The Fed’s decision to halt its aggressive money creation should, in theory, be beneficial for the dollar.
With fewer new dollars entering circulation, each existing dollar is likely to maintain its value, or even appreciate. Consequently, dollar-denominated assets, like oil and gold, should decrease in price. However, this is only part of the bigger picture, and last week’s events are just a snapshot in time.
It’s crucial to remember that the Fed’s zero interest rate policy remains in place, which inherently lowers the cost of money and credit. Thus, the Fed is still pursuing inflationary policies.
Cognitive Dissonance
We might be witnessing a new trend where the dollar appreciates while gold depreciates. However, we doubt this trend will be sustained into next year, as numerous factors could prompt the Fed to take counterproductive actions.
This brings us back to the stock market and the cognitive dissonance observed recently. For the last five years, quantitative easing has acted as a driving force behind stock prices. The Fed claimed its quantitative easing measures would promote employment and stimulate economic growth. In reality, it primarily led to inflated stock values.
When the Fed decides to turn off this monetary stimulus, it stands to reason that stock prices should decline. Yet, surprisingly, they ramped up.
The connection between the stock market and the actual economy was severed by monetary policy years ago. Therefore, it doesn’t matter if the economy shows signs of improvement or if corporate earnings rise. The stimulus propelling stocks higher is being withdrawn.
Despite the recent surge in stock prices, particularly the DOW and S&P 500 reaching record levels, we believe stocks are facing inevitable decline. We expect this correction to occur within the next few months, potentially before the year concludes.
Why You Should Prepare Now for the Fed’s Next Money Pumping Scheme
It’s a fundamental truth that stocks experience both upward and downward movements. After consistently rising for five years due to quantitative easing, a downward trend in stock prices appears likely.
Moreover, the absence of direct Fed purchases in financial markets means that the stock market must adapt to this new reality. The landscape that has characterized the past five years is changing, likely resulting in declining stock prices.
When the stock market does experience a significant drop, what actions will the Fed take? Will it remain passive and allow its interventions to unravel, or will it implement further measures to inject liquidity into the markets?
As we have learned from over 15 years of economic history, it is likely that the Fed will unleash substantial amounts of money and credit back into the financial system. This may come in the form of another round of quantitative easing or some new strategy they devise.
Importantly, such actions will lead to inflation. The dollar will lose purchasing power, and while there may be a temporary boost to the stock market, it will undoubtedly revitalize interest in gold.
It’s prudent to prepare now, during this phase when gold remains relatively cheap and stocks are overvalued.
Sincerely,
MN Gordon
for Economic Prism
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