Stocks Rally On Bernanke's Admission Of Fed Ineffectiveness

Includes: DIA, SPY
by: Daryl Montgomery

Stocks rallied Monday based on comments that Fed Chair Ben Bernanke made at the National Association for Business Economics spring conference. Long-term interest rates however went up.

The Dow Industrials rose 100 points not too long after the market's open, apparently on the hopes that more quantitative easing might be coming. Bernanke made no such promise in his talk and it would be a stretch to have made that interpretation, but as usual mainstream media reports put a positive spin on Bernanke's remarks.

The takeaway that got buried was that the Fed Chair admitted that the economy remained weak and there has been no significant recovery yet. In relation to job gains, Bernanke specifically stated, "we have not seen that in a persuasive way yet." He followed up by saying that without much stronger GDP growth, the unemployment rate was unlikely to fall much further.

Essentially, Bernanke's remarks are an admission that the Fed's policy of zero percent interest rates for almost three and a half years now and two rounds of quantitative easing (combined with trillion plus dollar budget deficits for four years in a row) have been a big dud. The average American however wouldn't know this based on what they read in the papers and hear on TV. There have been three years of reports from the mass media informing the public about the "recovery" that is taking place.

Every time Bernanke has made comments, whether specific or indirect, about more stimulus from the Fed, stocks have rallied strongly - one of the few things that easy money has accomplished. The Fed has also been successful in driving interest rates down, although this seems to be changing. Long-term rates rose on Bernanke's remarks even though the Fed's Operation Twist program is still ongoing. Mortgage rates, after being at all-time lows, rose above 4% last week.

Stock traders make their decisions on very short-term time horizons. Liquidity drives stock prices up, regardless of what else is going on in the background. Bernanke has delivered on greater liquidity on a massive scale since the Credit Crisis in 2008. Not surprisingly, the stock market has had a nice rally during that time. Liquidity was also behind the previous real estate market rally in the first years of the 2000s that led to the Credit Crisis and before that the late 1990s tech stock bubble that was followed by an 80% crash in the Nasdaq. There will be serious consequences again this time around, but that type of long-term thinking isn't an important consideration for most traders.

Investors should ask themselves,: If the Fed's ZIRP (zero interest rate policy) and money-printing quantitative easing are such good ideas, why haven't they been done before and why don't we just always do them? While ZIRP is historically unusual, money-printing is nothing new. It's been done hundreds of times (if not thousands) and has always been followed by major inflation and frequently hyperinflation. The risks of these policies are extreme and this is why they have been avoided by responsible governments throughout time.

Ben Bernanke is not worried about inflation though. He claims he hasn't seen it yet (obviously he doesn't go food shopping or buy gas for his car). Of course, U.S. government statistics are manipulated so it is difficult for them to show inflation except when it is really elevated. Inflation is also one of those things that once it shows up, it is difficult to stop - sort of like a tsunami.

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.