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Tuesday, 10th February 2015

Can the Fed save the stock market?  

Recently, a number of gold commentators have written that they do not see a significant decline in the stock market over the next year or so because the Fed will step in with further easing to prevent a rout. The perception is that the Fed can still save the stock market when it wants to. We disagree.

Fist, as mentioned in out February 5th note, the Fed cannot reverse course with QE or its announced policy of imminent rate increases without taking a major hit to its credibility. A reversal means that the previous easing did not work to achieve sustained economic growth, contrary to what the Fed has repeatedly told us. Any positive impact on the markets would therefore be short-lived, in our opinion.

There is a second reason for challenging the impact of Fed future Fed easing on a falling stock market-history shows it doesn't work. Dr. John Hussman notes in his February 8, 2015 commentary that "investors should remember that the Fed did not tighten in 1929, but instead began cutting interest rates on February 11, 1930 - nearly two and a half years before the market bottomed. The Fed cut rates on January 3, 2001 just as a two-year bear market collapse was starting, and kept cutting all the way down. The Fed cut the federal funds rate on September 18, 2007 - several weeks before the top of the market, and kept cutting all the way down."

As Hussman points out, Fed easing supports markets when investors are looking to take on more risk. Markets reliably signal a risk-seeking environment; credit spreads are tightening and almost all asset classes are advancing together (what Hussman calls uniformity). That's not what we have now.
Since mid-2014, we see widening credit spreads, deteriorating market internals such as breadth and key divergences including plunging commodity prices and collapsing Treasury yields.

In short, we don't see a reason for this to change:


Or, how many ounces of gold to buy the DJI Index


Note: Prior to 1896 a surrogate index is used for the DJIA Index.