(Picture: To prepare you for the information that you are about to learn we have to quietly and slowly use some psychological methods to ease you into this. We warn you that after reading this it will be difficult to remove these concepts from your investment process. Let us walk you through something incredible that a follower/commenter pushed us on.)
After this work, I am worried that the market is almost solely in the hands of decisions made by the Fed, but not through rates. Yellen holds our financial fate in her hands. Is that the way ("free") markets are supposed to work? We are in incredibly dangerous territory.
We think this has implications for banks, the consumer, investors, the economy and the world.
But we'll give you the facts of what we are looking at and you come to your own conclusion. Let's start.
To start, I want to give an incredible call out to SteveMDFP. He read our work better than we did yesterday.
In our report, Is The Fed Buying Stocks, we showed how the Fed's open market operations and balance sheet was the key driver to stock market moves. In fact, if you look at the correlations of Fed balance sheet changes to S&P 500 (NYSEARCA:SPY) returns, they hauntingly line up almost to a "t."
We'll show it again because it's a great chart. Here you go. Scroll slowly so you see each year's performance versus the "YOY Change" of Fed balance sheet assets.
You can see how the Fed changes in positions almost precisely told you how much the S&P 500 ETF would be up or down.
To this chart, SteveMDFP asked an amazing question. Buckle your seat-belts. He asked,
"I found the shocking number to be the 41% DECREASE in the balance sheet during 2008. My guess is they shrank the money supply with this step to rein in the overheated excesses in real estate financing--but precipitated the 2008 crash.
Of all the finger pointing that's been done about the crash, few have been blaming the Fed for actions in 2008 itself, but maybe they deserve the lion's share of blame for taking this precipitous action."
Looking deeper into our report, SteveMDFP caught on to a scary reality that the Fed themselves may have induced the '08 crash. Have you heard that before? We're about to show why that may be true.
We want to show a close up to his question. My hands are shaking writing this because it is just so powerful.
The green line is the S&P 500 ETF. The yellow line is the size of the book of open market operations (Fed buying is up, Fed selling is down).
I'm still shaking. If you put on your glasses you can see the Fed stopped buying and started selling (reducing its holdings) before the peak in October 2007. (Big disclaimer, please excuse my less-than professional charts, I'm jamming to show you a point).
The yellow line ticks down for the first time in years August 15th, 2007.
The yellow line starts its bigger slide down December 12th, 2007 and steeper on March 19th, 2008. Those are the times when the Fed stepped up selling.
Here's the numbers (we adjusted the Fed numbers to fit the SPY numbers, we divided the Fed balance sheet number by 6,000,000,000 so it would line up close to the SPY price). Watch the Fed number drop. That's the Fed selling taking liquidity from the market. Those sales matter and helped the market go down. And watch our key dates, Dec 12th, and worse, March 19th, for the change.
And here's the S&P chart in that timeframe.
The first line is August 13th which was the little baby drop in the yellow Fed line. The Fed barely started selling after a long string of a several year buying spree.
The second line is when the Fed really started selling securities, sapping liquidity from the market.
The third line is the Fed, we call it, panic selling of US assets. (Look at the numbers, that's not what you'd call it?)
The Fed, Maybe Solely Caused the 2008 Market Collapse
Please review the above if you too are not yet shaking, because it is material. We're not like other media outlets that have to say what the Fed wants us to say. We say what our work shows us and it shows us that The Fed may have caused the 08-09 collapse and recession. Look and see for yourself and decide for yourself.
Granted there may be many other factors in the market, but this is a main one. Add to that the Fed acknowledges its open market operations ("OMO") do impact the market. Simply, that's why they do them. They do OMO so they can affect the market and economy. So, the Fed, in those terms, would basically be admitting that they caused the collapse.
And Now For The Riveting Next Chapter
Hold on tight.
We're going to say a few key phrases and we want to hear from you what images now come to mind, ok? (I'll go slow and say them in hush so they don't hurt)
- Stress Tests
- Living Will
- Banking Crisis
- Bank Capital
- Too-Big to Fail
- Lehman Brothers (Sorry about that last one, it may have hurt despite the hush.)
In a new context do these phrases mean anything? The Fed pulling liquidity from the market tumbled banks and forced a Fed bail out.
Fed caused the crash and caused the need for their own bail-out.
Does that make any sense to you?
Frankly, I'll be surprised if this article doesn't get pulled by some banking authority for being too thoughtful (or maybe that's giving myself too much credit, but really I give a lot of the credit to SteveMDFP as I said above for asking a great question).
Now we understand why the Fed is grilling the banks
Putting my altruistic cap on, the Fed is right. The Fed does not want to be the main driver in the markets. If they ever went to college they learned in business class that a big government ultimately is bad for business and less government is good (Reaganomics).
And they see that the GDP is not moving even with their ton of "G." Equation taken from Professor Google.
"The following equation is used to calculate the GDP: GDP = C + I + G + (X - M) or GDP = private consumption + gross investment + government investment ("G") + government spending + (exports - imports). Nominal value changes due to shifts in quantity and price."
That's classroom, but the following chart is reality. Their G is not working.
And they know there will be consequences but they have to get off the drug but don't know how.
They know if they sell securities, they have another collapse on their hands.
Now we can understand stress tests
Stress tests and all the new legislation to control the banks are all a product of our yellow line above and its market impact.
If I was a Fed governor (That's like saying if I ever played for the Mets, no chance. If you can't tell I am/was a Met fan, I admit. I grew up in Queens so I have an excuse. Sorry lost it for a second dreaming of the old days...) If I was a Fed governor I would want to be weaning myself off the drugs/training wheels and let the economy run by itself. They are way too involved. They have to know that. The government, based on our yellow line, is WAY too important, and we are all at their decisional mercy.
Let's opine. If the Fed ever wanted to get off the medicine, they need to prepare. How? Stress tests, living will, Dodd-Frank. Much of this legislation is directly in the hands of the Fed. We'd guess they want to pull back on the yellow line and let the economy grow up on its own. To do that they need to hunker down all the weak links. Who are they? The banks.
Our yellow line is forcing them to push the bank capital much higher.
We think it's not over. The Fed is staring down this potential series of outcomes as they want to tighten. If they pull the plug through OMO they know the banks are going to take a hit and many will not survive (I dare say). They want to save the economy.
The Fed, FDIC and the government all say they will not bail-out. It is next to impossible that they will not, however. If that yellow line ever turns down and they do not step in to help banks.......(please don't make me say it).
Use your own word for that scary market reality.
Please Grab Your Softest Pillow, Now. We'll Do This Gently
We apologize for the chart we are about to show you. This chart shows you where we are in comparison to the 2008 crash. It's fair that the Fed sales had something to do with the market in 2008. If so, ...
Please accept my apologies. There was no preparing you for that chart. Look at 2008 and look at today. I have no words to describe the amount of risk that we are currently in. If any of our analysis is even partially correct, shop for canned goods.
We did nothing fancy here. We just showed you the facts. I am shaking again. I don't know if it's going to go away.
We have reason to believe that the Fed open market operations of selling securities may have been the key prelude to the meltdown in 2008-2009.
Taking that a step further, we believe that the Fed and the government hopefully want to get off the habit of providing this liquidity forever. If they ever pull back, it will most likely be painful.
If they read this article before the stress test results later this month, or maybe they are already thinking about it (maybe?), then we could be headed for higher capital limits and tighter all around standards.
We are all at the Fed's mercy (sounds like some movie you don't let your kids see).
A big thanks, again to SteveMDFP for forcing us to think. Great question, and I hope we gave you a good answer.
Good luck and please, everybody be in touch. All of your comments teach US a ton and give us the best ideas for what to write next!! Especially after the last couple of days with SteveMDFP and bullsbearspigs who challenged us to come up with the idea for Is The Fed Buying Stocks.
Elazar Advisors, LLC specializes in earnings and predicts, analyzes and reacts to earnings and earnings events as well as developing current company and macro stories with a hedge fund perspective.
If you want Elazar's analysis on Seeking Alpha, scroll to the top of the article and hit "Follow." Elazar also writes real-time pieces as earnings and news are reported on Seeking Alpha. If you want to be among the first updated, be sure to check the box for "Real-time alerts on this author" under "Follow."
Disclaimer: All investments have many risks and can lose principal in the short and long term. This article is for information purposes only. By reading this you agree, understand and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Chaim Siegel, Elazar Advisors, LLC, bestideas, their related parties, and its authors harmless.
Disclosure: I am/we are short ES WHICH CAN CHANGE AT ANY TIME.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.