Investors Respond to Rules Change By “Getting Out”

CoverFederal Reserve Changes The Rules For The Economy

In the Famous 1999 Movie “The Matrix” there is a scene where Neo, Morphues and their crew are inside the Matrix on a reconnaissance mission.  While in the Matrix, Neo notices a cat walking by a doorway and then shortly later the same cat walks by again which causes Neo to remark “Deja Vu”.  Upon hearing Neo say Deja Vu, Morpheus and the rest of the crew immediately realize that they are suddenly in danger.  Trinity explains to Neo that “A Deja Vu is a glitch in the Matrix… it happens when they change something”.

At the same time, crewman Tank is inside the ship watching several computer  monitors where a series of 1’s & 0’s are moving down the screens in their usual order.  Tank then notices a change in the patterns of 1’s & 0’s on his screens.  Tank immediately realizes that something has been changed in the order of the Matrix and that Danger is now present.  Tank gets on the telephone and tells the crew inside the Matrix that “It’s a Trap ” and to immediately “Get Out”.

Here is the famous Deja Vu scene from the 1999 Matrix Movie.

 

 

I am reminded of this scene because of the action in the stock market this past week.  On Wednesday “They”  – the Federal Reserve  – changed the rules of their easy money policies that have been in place since the stock market crash in 2007 – 2009.  In response to the crash the Federal Reserve introduced a number of different easy monetary policies.  These easy monetary policies that arose from the financial crises of 2007 – 2009 have ended up being very supportive of the economic matrix which is also known collectively as the business environment, the stock market, the housing market and the overall economy.

This week on Wednesday afternoon the Federal Reserve announced that if the economic data continues to improve they will end their Quantitative Easing programs sometime between the end of this year and the middle of 2014.  Quantitative Easing are the programs that has brought the country the all-time record low interest rates which have been the primary catalysts for reversing the decline and then propelling both housing markets and the stock markets higher.

Now the Deja Vu moment for investors in the stock markets is that in the prior two major stock market corrections over the past decade – the technology stock correction beginning in the year 2000 & the 2007 – 2009 financial crises correction – both  got their start after the Federal Reserve began tightening their easy monetary policies and raising interest rates over a short period of time.

It appears that market participants have an excellent memory of the 2000, and 2007-2009 corrections because they responded to the Federal Reserve change of their monetary policies by sensing danger and heeding Tank’s call in the Matrix by “Getting Out”.

Below is a One Week chart that illustrates investors reaction to the Federal Reserve announcing the potential end of the Federal Reserve support easy monetary policies and record low interest rates on Wednesday afternoon.

 

(Click on Image of Chart for a Bigger Picture)

S&P 500  5 day chart

 

It is important to note that the Federal Reserve did state that the amount of support for the economy that they will provide in the future will be “data dependent” – meaning if the future economic growth is not as strong as their projections then they will adjust their timeline for ending their monetary actions that have been so supportive of the economy and the stock and housing markets since 2009.

However, based on the 4.5% market sell-off that occurred right after the Federal Reserve announced their change in monetary policy – Investors found no solace in the data dependency of future monetary policy from the Federal Reserve.

 

How Exactly Has The Federal Reserve Helped The Stock Market?

In response to the financial crises of 2007 – 2009 the Federal Reserve took numerous unprecedented actions to “save the economy”.  Among them were what is known as Quantitative Easing #1, #2 & #3.  A simpler way of referring to all these actions that the Federal Reserve took to respond to the financial crises is what is known as “Money Printing”.

Just how much money did the Federal Reserve Print?

I have a chart of the Adjusted Monetary Base.  The Adjusted Monetary Base is the sum of currency in circulation plus deposits held by depository institutions at Federal Reserve Banks.  In summary, the Adjusted Monetary Base is the total amount of US money that has been printed by the Federal Reserve and placed into circulation.

Just how much money have been printed over the past 5 years?

Below is a chart of the Adjusted Monetary Base from 1985 – 2013.  Note how in the last 5 years beginning with the economic crises of 2009 – the amount of money in circulation has grown 400%  – Yes 400% – to 3.2 Trillion.

 

(Click on Image of Chart for a Bigger Picture)

Adjusted Monetary Base

 

All of this monetary support from the Federal Reserve over the last 5 years would eventually makes its way  into the stock market.

Below is a chart of the S&P 500 that begins at the financial crises lows in 2009 through today.  Note how the accommodating money printing policies of the Federal Reserve helped to create one of the better stock market rallies (147%) of all time.

 

(Click on Image of Chart for a Bigger Picture)

S&P 147% Gain

 

Now you can see why this week when the Federal Reserve announced their intention of withdrawing their historic amount of monetary support for the economy  – it was greeted by investors deciding – at least for the first two days – to get out.

 

Closing Thoughts

Wednesdays announcement by the Federal Reserve is indeed a game changer.  US markets were not the only markets affected by the Federal Reserve announcement.  Nearly all international markets sold off to the tune of 3% – 7% on the news from the Federal Reserve.

Moving forward I would expect more volatility in the stock markets and in your portfolio results each quarter as every new economic report will have extra impact than before.   Each report will be scrutinized by the investment community to determine if the Federal Reserve will either speed up or slow down in it’s support for the economy.  Then the markets will move accordingly.

I think for the next six months, an increase in volatility (i.e. movement up and down) in the stock markets should be an expected result of the game changing Federal Reserve announcement this past Wednesday.

 

 

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