It should come as no surprise to any investment professional who takes risk management seriously that today's market "melt up" reflects the worst Fed policy decision ever (or at least the continuation of one). No more than a month ago the Fed sent a shot across the bow of highly leveraged speculators telling them that the era of endless stimulus was going to end.
Well, not "end" exactly. They really said that at some point the $85 billion of monthly purchases would start to taper down to some unknown amount, probably in the range of $40-65 billion a month.
The markets threw a fit: U.S. Real estate down 15% in a month (IYR), 20-30 year U.S. Treasuries down 13% from their April highs (TLT), Emerging Market equities down 17% (EEM), commodities down double-digits (GLD). Anyone seriously thinking that today's market isn't entirely dependent on further seemingly endless stimulus is just flat-out naive.
Best described as a "taper-tantrum," the market reaction of over the past six weeks is EXACTLY like a little kid walking into a candy store with his dad, getting one lollipop and demanding 10 more. When the dad says "no," the kid throws a fit, screams, cries, yells, threatens - at which time the dad gives in.
What kind of a message does that send? I'll tell you:
I was at Schwab Impact last fall in Chicago and a wholesaler from one of America's oldest mutual fund companies was peddling his funds, touting their emphasis on risk management (never mind that his definition of risk management - being down only 34% in 2008 instead of the S&P's 37% - is really not that impressive). He told me that risk management is really nothing more than a ruse because they're really counting on Fed policy to remain accommodative forever. "Don't manage risk; simply accept it and if the market falters the Fed will come to the rescue."
This, my friends, is the epitome of moral hazard: the markets now expect endless stimulus because the Fed has given in - again and again. When they hinted that the party might be over, the markets threw a fit, and Bernanke appeased them. (So did Chamberlain, and that didn't end so well).
It's really bad policy to buy growth (as the Fed is doing) for anything more than a short period of time precisely because it sends capital into the hands of those most likely to squander it. Easy come, easy go, but the cost to the taxpayers and to society in general is outlandish.
"If you don't give me what I want I'll take my baseball and go home" is the kind of attitude that should be treated with the tough love that capitalism deserves. If the economy is so dependent on the promise of endless stimulus that it simply can't stand on its own by now, then what's the point of throwing more fuel on the fire? What exactly are we defending?
Frederick II famously said that, "To defend everything is to defend nothing" meaning that you have to be smart about the battles you pick. Defending capitalism by merely socializing capital is fine for a time (which is what stimulus is supposed to do), so long as there are reasonable limits to size and scope. Having no true limits, the Fed is attempting to keep balloon of the markets inflated through artificial means rather than by letting actual demand define market valuations.
If without more stimulus we're truly doomed (as the taper tantrum would certainly indicate), then we're in a real pickle.
I welcome your thoughts...