Editor's note: This article originally published on September 18, 2012.
In the afterglow of the Federal Reserve’s Buzz Lightyear “to infinity and beyond” commitment to purchase up to an unlimited amount of financial assets until... well, until, the financial and media pundit comments have been simple, clear, and extraordinarily consistent. For example, from the MarketBeat blog of the Wall Street Journal
: “Does anybody have any doubt that the major indexes will hit all-time highs?” Or this from The Economist
: “Who would bet against a central bank that can conjure money from thin air?”
While on the surface, these comments should be viewed as positive indicators for the market and what is ahead for investors, I am afraid that as a socionomist, my take is much more the reverse.
What is clear from the market’s messages from the past four days is that the Federal Reserve has finally succeeded in convincing investors that they should not fight the Fed. Lest there were any lingering doubts, the Fed made it clear that it will use, if necessary, unlimited resources for as long as it takes to lower unemployment. Not only has tail risk been eliminated, but all risk has been eliminated. Markets can and will only go up from here. Maybe it is just me, but the investor sentiment of this certainty (that the Fed is willing and able to deliver effective monetary policy to continue to propel markets higher) is saturating. But what I see as a result is no longer well-reasoned belief, but self-assured capitulation and compliance. To talk with investors, the choice is that there is no choice. We believe because we must believe, particularly as everyone else believes as well.
Ironically, what I am afraid that the Fed (and the ECB) has created is a golden cage in which compliance is generously rewarded, while a failure to comply results in financial water boarding. Again, the choice is that there is no choice. As they say in the film The Ten Commandments
, for the markets, it is now, “Row and live.”
My concerns with this resulting position for the Fed are twofold. First, having announced and resorted to its nuclear option of “unlimited demand for an unlimited period,” the Federal Reserve has communicated to the markets that from here on out, we have “unlimited bid, limited offer" markets.
What I am afraid that neither policymakers nor most investors appreciate is that it is not actual demand, but rather perceived demand, that drives market prices. Because markets are driven by social mood and confidence, they are inherently forward looking. And what is perceived to be ahead matters more to price than what is on the table today. Unfortunately, I am afraid that by their actions recently, central bankers globally have taken the perception of future demand to such an extreme that any incremental private sector demand is meaningless. When you already have a market perceived to be made up of “unlimited bid, limited offer,” how does another $100 or $200 billion in cash on the sidelines really matter to price? Even more, I am troubled by the self-assured certainty that market participants now have regarding central bank strength and the resulting compliant behaviors that I see. What I am afraid most investors miss is that our confidence in central bankers reflects our own level of confidence. Go back and look at what financial and media pundits were saying about the willingness and ability of policymakers to act and the effectiveness of policymaker actions at major market bottoms. From Jim Cramer’s “They know nothing!” rant to The Economist’
s “BE AFRAID” cover – both of which tie to major market troughs – the sentiment is clear.
What is uncertain to me is how falling confidence will impact a clearly now-compliant market; and with the divergence between equity market values and consumer confidence at a record extreme, I don’t trust the market’s true underpinnings. As we have seen recently with Arab Spring, the societal migration from uniform compliance to a condition that reflects very weak underlying social mood can be dramatic and quick. Even more, the rebuilding process thereafter is worrisomely volatile and slow.
To be clear, I hope that all of these thoughts prove to be the concerns of a worrywart. Still, I can’t help but take note of the self-assured certainty that I see in the markets today.
Needless to say, it will be interesting to see where it all goes from here.
Peter Atwater's groundbreaking book "Moods and Markets" is now available for pre-order on Amazon and Barnes & Noble.
“Peter Atwater brilliantly provides a framework for understanding both the socioeconomic hubris that led to the great credit bubble of the past decade and the dark social-psychological hangover that has resulted from its collapse. In so doing, he offers an invaluable guide to what promises to be a very difficult and turbulent period ahead as we experience what he calls the ‘me, here, and now’ behavioral tendencies of the post-crash world.” —Sherle R. Schwenninger, Director, Economic Growth Program, New America Foundation
Position in SH and JPM.
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