The Federal Reserve and the Astonishing Stock Rally

Insights and Market Perspectives

Author: Greg Valliere

August 19, 2020

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THE FEDERAL RESERVE has fueled a mind-boggling stock rally, and is prepared to do even more if the economy falters. Ironically, the Fed’s remarkable role in providing rocket fuel for the S&P’s record high is not widely appreciated in Washington.

PRESIDENT TRUMP GRUMBLES whenever Jerome Powell says the economic risks are still downside risks. Democrats grumble that the Fed is creating a bubble in stocks, helping the wealthy and promoting a false narrative that the economy has recovered.

YET THE FED WILL NOT RELENT, as it steps up lending and offers assurances that the fed funds rate will stay close to zero for perhaps another two years. Powell and his colleagues worry that fiscal stimulus is inadequate, as Congress gridlocks over a scaled-back bill.

THE NUMBERS ARE ASTONISHING: Stock valuations are soaring — Amazon is up by about 80% since March, Apple is up by 57%. Some of this is a product of great earnings, some of this is because there are few investment alternatives, some of this comes from hyped-up day traders. But much of the rally has been stimulated by the Fed.

ON THE LEFT, THERE’S ANGER that small businesses are struggling, and there’s anger over the mantra that “the stock market is the economy.” All of the companies in the S&P employ only about one-fifth of the nation’s workers; most employees work for small businesses, which are struggling.

MOREOVER, while 84% of American households with income over $100,000 own stocks, only 22% of households earning $40,000 or less own stocks, according to a Gallup survey. Bernie Sanders said recently that “this is the most massive transfer of wealth in American history.”

THE FED, IN OUR OPINION, HAD NO CHOICE: The central bankers had to avoid another Great Depression this spring, and they did. The Fed has added $2.8 trillion to its balance sheet since February, and money supply is up by an astounding 22% in the past year.

ONLY ONE THING COULD SLOW THE FED’S ACCOMMODATION — A sudden pickup of inflation or inflation expectations. There’s been a whiff of inflation this summer, but for now the Fed is more concerned about deflation than inflation. We think there’s a real threat of higher inflation, but it’s not an imminent threat.

WITH THE FED’S FOOT ON THE ACCELERATOR, it’s difficult to see a major selloff or a recession anytime soon. Could signs of a stock bubble lead to a market correction? Maybe — but if there’s a serious correction, the Fed will come to the rescue once again.