The Fed has created a very very dangerous situation.
Ever since 2009, anytime the markets came close to breaking down, “someone” (read: the FED) has stepped in a propped the markets up.
In 2010, the S&P 500 staged a death cross, where its 50-DMA broke below its 126-DMA (the half year moving average). Stocks were in a perilous state with the 2008 Crash still in everyone’s short-term memory.
The Fed stepped in, hinting at, then all but promising, and then finally launching QE 2 in July, August, and then November, respectively.
This set off a rally in stocks that lasted until the EU Crisis erupted in full force in 2011. Once again stocks staged a death cross. And once again, the Fed stepped in with promises of action followed by the announcement of Operation Twist in September 2011. Stocks took off and we were back to the races.
Which brings us to 2012. Europe was really going down in flames. Greece, then Portugal, and even Spain were lining up for bailouts. And the bailouts were getting larger by the month with Spain requesting €100 billion in June 2012.
ECB President Mario Draghi promised to do “whatever it takes” to hold the EU together. But the carnage was spilling over even into US markets. So Bernanke’s Fed promised yet another QE program, though this new program would be “open-ended” in June.
Sure enough, Bernanke unveiled QE 3 in September 2012. He then upped the ante, unveiling QE 4 in November 2012.
Stocks took off again, launching one of the sharpest, strongest rallies in history.
This same madness has continued despite the Fed ending its QE efforts. Last month the markets took a nosedive to critical support. This time around rather than launching a new monetary policy, a Fed President stepped out and hinted that the Fed should consider postponing the end of QE (a mindless statement given the Fed had only $5 billion in QE left at the time.
Logic aside, the markets took the hint and erupted higher again.
In simple terms, the Fed has completely conditioned the markets to believe that NO MATTER WHAT stocks will be held up.
This policy has worked fine… but eventually it will fail, just as all market props do. Eventually the investment herd will begin to sell/ take profits. And at some point there will be a selling panic.
Gauging when this will happen is impossible as we are now talking about crowd psychology, not market fundamentals or economic data (neither of which have mattered for over two years).
However, the fact remains that all bubbles burst. This bubble will be no different other than the fact that it was in fact been the FED that created and perpetuated it long after it normally would have burst.
Put another way, when the next crisis hits, the Fed will effectively be out of ammo as it will be a crisis of faith in the Fed. Whenever investors themselves begin to comprehend that the Fed is now more leveraged than many of the investment banks were when they went bust in 2008, the end game will begin.
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