The Fed As A Fig Leaf

Everyone who has been wrong about the market has now joined in a familiar refrain:

The Fed is printing money. It is the only thing holding up stocks. It will all end badly.

Background
A little research on these sources shows that – as of a few months ago – their take on the Fed included the following:

• The Fed is irrelevant
• The Fed is pushing on a string
• The Fed is in a box
• The effectiveness of QE has declined with each new round.

When the various bearish predictions have not played out, the same sources come up with a NEW VERSION of the theory. In this revised story, no one could possibly have predicted the effect of the Fed's money printing and debasement of the currency. Wow!

Once again this flies in the face of facts:

1. While the Fed's balance sheet has increased, M2 growth has been modest. Whatever "printing" is taking place seems to be stalled at the level of excess reserves.
2. The dollar has actually strengthened. In fact, there is no real correlation to Fed policy – despite the rhetoric.

But it is an easy explanation. Blaming the Fed is a fig leaf for bad analysis.

The Reality – An Alternative Hypothesis

There is a simple reason for higher stock prices: Better economic conditions and higher profits. Over the last three years the most important market worries have lessened.

Most people struggle to understand the "wall of worry" concept. Briefly put, it means that, at any given time, stock prices might be lower than one expected because of headline risks. These are plentiful at all times, fueled by ratings-seeking media and blogs. Trying to explain how Europe will bargain its way to a solution is pretty boring when compared to footage of a run on banks in Cyprus!

It is very difficult to evaluate the worries in real time. To avoid this problem, let us use the Wayback machine to go back three years. In my Dow 20K series, I raised a number of "what if" questions. The commenters were most of the "Miller, you idiot" persuasion. Feel free to go back and first installment . My next post will ask what the effect would be if the Fed unwound the entire balance sheet in one year. What is your guess? Let us suppose two methods:

1. No notice at all.
2. Announcement of the general plan, but without daily or weekly specifics.

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We all know that it could not happen in either of these alternatives, but let us consider them as a useful hypothetical starting point.

Written By: Jeff Miller