The Federal Reserve Will Not Produce A Bull Market

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The concept of the U.S. Federal Reserve acting to support stock market prices.

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Ignore the Federal Reserve’s easy money ploy. The supposed magic powers are unfounded. There is too much economic blah ahead to be somehow cured by lower interest rates. No Federal Reserve policy will produce a bull market repeat. (Proof? Think about Europe. Not even negative rates can boost a lackluster economy or industry.)

President Trump presses for lower rates, but not because they provide sound economic growth. Rather, the idea comes from his real estate developer mindset that lower rates and higher leverage mean higher profits.

Although it is being labeled a success, the past ten years have shown that abnormally low interest rates do not produce growth. Instead, the extended period consistently failed to deliver the economic bliss promised. Remember that for most of the years, the Fed’s policies brought only disappointingly lower-than-forecast economic growth rates, slower-than-desired employment gains and unusually low inflation, particularly given the monetary ease. (Extending this tiresome streak was the failure to recognize the problem and the Fed’s use of low growth, etc. as reasons to keep the easy money / low interest rate attempt in place.)

Note: Rarely (never?) discussed is the plight of savers, investors, banks, insurers, annuity providers, trust/pension/endowment/nonprofit/government funds that depend on safe, interest-bearing securities. $Trillions have been invested at near 0% for most of the past decade, subjected to inflation’s steady erosion of purchasing power. We can rightly label this as income inequality between lender and borrower.

So, what about the benefits produced by borrowers? Did they compensate for the financial system meddling?

Unfortunately, the abnormally low rates appear to have produced limited, even negative, effects.

Think of the situation this way: If the Fed had sat back and allowed capital markets to set the price of borrowed capital (a key ingredient of capitalism), companies’ cost of capital would have been properly determined. The result would have been sound company decisions (not to mention ensuring a proper return for the capital providers).  By contrast, the Fed’s abnormally low interest rates incentivized the unhealthy activities we have seen:

  • Stock price boosting through increased leveraging (for example, borrowing for stock buybacks and increased dividends)
  • Dubious business decisions based on low interest rate cost, not the higher, true cost of capital (for example, overpriced acquisitions and questionable capital investments, ending in supply gluts)
  • Causing investors to take inordinate risks in order to increase their meager returns

All in all, there have been (and still are) numerous disturbances and distortions that flow through the financial system because of the Fed’s interest rate control.

This time, expect weaker outcomes

We should not expect anything better this time. In fact, we will likely see less benefit because the companies that made unsound acquisitions or unwarranted capital expenditures will not be in a position to repeat their mistakes. The same goes for the higher leveraged companies that spent their borrowings on buybacks and dividends in the attempt to bump their stocks.

Then there is the U.S. government. Expect the low rate to help, but not in terms of expansion, like infrastructure spending. With annual deficits (new borrowing) running around $1T, the Fed’s low rate policy can keep the interest payments abnormally low – for the time being. However, the reality is known in Congress and Wall Street that interest rate expenses will rise – through added borrowing and the eventual return of market-based interest rates.

That leaves consumers – us. With the latest consumer credit report showing heady borrowing, will lower rates encourage us to borrow and buy even more? Perhaps, but such past periods of heavy consumer borrowing seldom have happy endings.

The bottom line

The Federal Reserve’s interest rate management is not the solution to slowing growth. In fact, by overriding the capital market’s interest rate setting prowess, the Fed is creating a stumbling block. Why not trust capitalism to balance the imbalances, incentivize the correct actions and properly reward risk taken by lenders and investors? Such a shift would also remove the uncertainty created by the Federal Reserve’s management and mismanagement (Will they, or won’t they? When will they? How much will they? What if…???).

Okay, that is not going to happen – yet. However, we can know that a further interest rate cut will not produce any real, lasting benefits, including a bull market.

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