Markets have been testing the Fed ever since Chair Powell indicated that rates are headed higher and their balance sheet will start shrinking.
There’s nothing new about this. In the 1980s, then-Fed Chair Alan Greenspan responded to the stock market crash with monetary policy. Ever since then, markets have believed, with increasing strength, that the Fed would bail out the market.
In fact, the phenomenon was given a name: the Greenspan put.
A put option is a derivative contract that gives the owner of the put option a floor on their losses. Although Greenspan and the Fed did not engage in an explicit contract, the market view was that the Fed would provide a measure of insurance against falling asset prices.
That implied insurance doesn’t work perfectly. Take the 2008 global financial crisis: the stock market lost -55 percent, but there is no question that the Fed’s policies kept stocks from falling further.
As Fed Chairs changed from Greenspan to Bernanke, Yellen, and now Powell, the put concept followed. Any questions about the ‘Powell put’ were answered when the pandemic first hit and he brought out the bazooka.
When Powell indicated early this month that the Fed was ready to raise rates and end the Fed’s quantitative easing program, the market decided to test the strength of the Powell put.
As markets sold off aggressively, the question at hand was whether Powell would back off of the plans and say that markets were too aggressive in the policy changes to come.
At the meeting last week, Powell held his ground. I have to admit that as much I don’t like to see the market go down, I was glad to see that Powell didn’t cave in to the markets.
And while everything is selling off, it’s the frothy parts of the markets that are suffering the most. Bitcoin is down by more than 50 percent, and other cryptos are faring the same or worse. Of the 30 $1-billion Initial Public Offerings (IPOs) last year, only six are at their list price. SPACs are faring even worse. Meme stock investors are apparently favoring blue chips.
It’s impossible to know where markets will go from here, but I cant’ say that I’m bothered by this market right now. Again, I would prefer it if markets never fell, but one thing you know about stock investing is that you’ll go through a lot of very rough patches and even more modest ones.
Seeing the froth come out of markets is a good thing, in my view. I’m a little old-fashioned, but I think markets make the most sense when investors consider the economic fundamentals of companies and do their best to pay fair prices. A lot of these other things are fun to hear about but are hardly sustainable.
I think it’s also useful to remember that January isn’t even over yet – a lot can happen between now and year-end.