Testing the Fed’s Narrative with the Fed’s Data: QT Edition
If 2018 rings in a bear market, it could look something like the Kennedy Slide of 1962.
That was my conclusion in “Riding the Slide,” published in early September, where I showed that the Kennedy Slide was unique among bear markets of the last eighty years. It was the only bear that wasn’t obviously provoked by rising inflation, tightening monetary policy, deteriorating credit markets or, less commonly, world war or depression.
Moreover, market conditions leading up to the Slide should be familiar—they’re not too far from market conditions since Donald Trump won the 2016 presidential election. In the first year after Kennedy’s election, as in the first year after Trump’s election, inflation seemed under control, interest rates were low, credit spreads were tight, and the economy was growing. And, in both cases, the stock market was booming.
Here’s an updated look at Trump’s stock rally versus the Kennedy rally and subsequent Slide:
As you can see, we’ve now reached the chart’s critical juncture—at this time of the calendar in 1962, the post-election rally was ending, and the Slide was about to begin. Our chart begs the question: Will the similarities continue and lead us into a Trump Slide in early 2018?
Or, with less drama, you might like to hear my Q1 stock market outlook.
In September, we proposed a theory of the Fed and suggested the FOMC will soon worry mostly about financial imbalances without much concern for recession risks. We reached that conclusion by weighing the reputational pitfalls faced by the economists on the committee, but now we’ll add more meat to our argument, using financial flows data released last week.
We’ve created two charts, beginning with a look at cumulative, inflation-adjusted asset gains during the last seven business cycles:
The world hardly needs another theory of the Fed, especially so soon after its Jackson Hole symposium. But we have a theory, too, and who knows, ours could be as close to the bulls-eye as any of the others. Plus, our theory is easy to explain—it rests on the simple premise that decision makers worry mostly about their reputations. We’ll propose that reputational risks are the primary drivers of central bank policies, and then we’ll use that belief to predict a major policy shift.