- Sudden and swift declines in the stock market have become a more regular occurrence.
- The recoveries from these declines are just as rapid, which does not characterize typical investor behavior.
- It appears as though there is an outside force, with motives consistent with those of the Federal Reserve, that is supporting market prices.
- The short-term benefits of manipulation that leads to wealth creation, should it be occurring, destroys the credibility of our markets, and ultimately leads to wealth destruction.
These are extraordinary times. These are times when central banks are taking unprecedented measures to revive our economy. So I suppose it should come as no surprise that we might see unprecedented and extra ordinary price activity in our stock market.
During each of the four quarters of 2014 we had one very abrupt decline in the stock market. On each occasion the S&P 500 (SPY) fell approximately 100 points (5%), with the exception being the October decline of 200 points (nearly 10%). The fifth and most recent decline started on December 30, 2014, and ended five trading days later after the S&P 500 had fallen nearly 100 points to its intraday low on January 6. Each sell off was truly breathtaking in terms of its speed and ferocity in relation to the unusually low levels of volatility that preceded it.
What was extra ordinary in each instance was the recovery in the benchmark indices that followed. The market would halt its decline on a dime, then immediately reverse course and recover all of the lost ground with the same speed that characterized the decline. In my 22 years of market observation, I have never seen such powerful and immediate recoveries on a recurring basis. It does not typify normal market behavior, yet each time it happens I hear that it is the proverbial "money on the sidelines" coming back into the market, as investors see a buying opportunity. I find this hard to believe.
Often the majority of the gains during these market rebounds occur overnight in the futures market. In other words, if the S&P 500 index rallies 20 points each day for three consecutive days, the majority of those points manifest themselves between the prior day's close and the following day's open in the futures market. The cash market then adjusts higher at the opening to reflect the bullish overnight activity in the futures market.
I suppose this could be some amalgam of high-frequency trading and hedge fund activity, but it seems more coordinated than that. I see a pattern. I envision a very large buyer with deep pockets who repeatedly steps into the equity market, and/or equity futures market, in an effort to support prices rather than to push them significantly higher. It is as though the stock market were an antique vase that someone was attempting to balance on an uneven surface. It simply will not stand upright on its own. Each time this someone begins to let it go, it starts to tip over, and so must be caught and returned to its upright position.
There is a small minority of market commentators, considered conspiracy theorists by the mainstream, who claim the Federal Reserve has been active in the stock market, purchasing the stock indices or futures on the indices, in order to prop up prices. Otherwise known as the "plunge protection team," this group of former Wall Street traders, concealed behind closed doors deep within the money management wing of the New York Fed, steps into the market with deep pockets when prices start to fall. This is of course nothing but conjecture. No one has any proof. Yet we do know that the Federal Reserve has had an impact on the stock market, which has been waning over the course of the past year as the Fed's final quantitative easing program (QE) came to an end on October 31.
No one has a roadmap that shows precisely how the money created by the Fed ($3.5 trillion) from its QE programs works its way into the stock market, but the tight correlation between QE and stock market performance is obvious. Jim Bianco of Bianco Research has been continuously updating this chart he created to show that correlation.
My roadmap looks like this -- the Fed would buy Treasury bonds and/or mortgage-backed securities from the primary dealers, which are Wall Street banks, and credit the accounts of the primary dealers with newly created money. The banks would then withdraw all or part of that deposit to purchase bonds from other institutions, paying those institutions with the money that was previously given to them by the Fed. That money would then be used to purchase other categories of financial assets, including common stocks. As the above chart reveals, during the periods when the Fed was not purchasing debt on a daily basis, the stock market declined. During most of last year the Fed was slowly tapering its purchases, which clearly led to a more subdued stock market performance, until it finally ended on October 31 with the S&P 500 at approximately 2000. We haven't made much headway since that time.
The Federal Reserve has accomplished very little with its extraordinary measures as it relates to its mandate of full employment and price stability, at least nothing that would not have otherwise occurred on its own under the normal circumstances of the business cycle. It has had an enormous impact on the stock market, both directly and indirectly, which has been its intent in order to stimulate a wealth effect. This may be its only confirmable accomplishment. As such, it surely fears what might happen to its reputation and our fragile economic recovery if the stock market were to decline substantially for any length of time.
Is there an invisible hand that has sporadically stepped into the stock market to support prices over the past year when the benchmark indices fall a certain percentage? Perhaps this activity was intended to offset the gradually declining flow of liquidity that QE provided. It could be consider a steroid shot instead of the intravenous method of stock market medication. Who is this invisible hand, if one does exist? I know that the Fed is not permitted to buy stocks directly, but nothing prevents it from establishing and funding a special purpose vehicle (SPV) that could be managed by another institution to help further its objective. Goldman Sachs would be a logical choice, or perhaps one of the large and politically connected hedge funds. I think these are legitimate questions that need to be asked, but the consequences for anyone with a platform could be dire.
In an interview on CNBC that took place in the midst of the financial crisis in 2008, a gentleman who was a regular guest on the show, and considered a knowledgeable Wall Street insider, surmised that a "plunge protection team" was at work in the markets. His credibility was summarily called into question by the hosts of the show and the other guests. It was shocking. Why?
The reason that investment professionals, government officials and members of the media no longer ask tough questions is that they don't want to risk the platform they have, their access to power and the hands that feed them, their credibility with the establishment (not the public), their income, and their future earnings potential. They don't want to lose access to the revolving door that exists between Wall Street, government and global corporations. As for me, I don't have to worry about any of those things, since I have no platform to lose, so I'm asking the question. Is the Federal Reserve manipulating the stock market?
I know that famed investors like Warren Buffet and Jack Bogle could care less about the answer to this question. Both would say they are long-term investors, and that short-term movements in the market, in either direction, don't matter. That simply is not reality for most individual investors. Although most individual investors probably don't care either in this case, because the manipulation, if it is occurring, is to the upside. No one wants to interfere with activity, manipulative or not, that is creating wealth for everyone.
I argue that if there is manipulative activity occurring, regardless of whether it is resulting in profits for all investors or not, it destroys the credibility of our markets. It is interfering with the uninhibited forces of supply and demand that result in true price discovery. That is fraud. And it eventually results in a price reversal, or payback, if the price manipulation does not in turn affect the fundamental improvement needed to validate the ever increasing prices.
This article was written by
Lawrence is the publisher of The Portfolio Architect. He has been managing portfolios for individual investors for 30 years, starting his career as a Financial Consultant in 1993 with Merrill Lynch and working in the same capacity for several other Wall Street firms before realizing his long-term goal of complete independence when he founded Fuller Asset Management. In addition to writing for Seeking Alpha, he is also a Leader on the new fintech platform at Follow.co.
Analyst’s Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.