This is starting to look a lot like the popping of the dot-com bubble with one big difference — inflation.
Beginning in mid-June, we saw a significant bear market rally in stocks. But the recent declines have wiped out those gains and more. For instance, the Dow jumped 14% during the 2-month rally. By the close on Friday, Sept. 23, it was once again down 20% from its all-time high. That same day, the NASDAQ closed just 2% off its June low after a 23% rally.
As WolfStreet points out, the collapse of this bear market rally was predicated on the fantasy of a Federal Reserve pivot.
“The bear-market rally happened because markets – meaning folks and algos playing in them – had this fabulous reaction to the Fed’s aggressive rate-hike scenario: They began fantasizing about a Fed “pivot” and about rate cuts and some even about QE all over again. Asset prices began to jump and yields began to fall.”
WolfStreet points out that this bear market rally is reminiscent of the dot-com era. During a similar two-month rally from May 27 through July 17, 2000, the NASDAQ jumped by 33% without ever getting back to its old high. Ultimately, the NASDAQ collapsed by 78%.
“That bear-market rally in the summer of 2000 suckered a lot of people back into the market, thinking that stocks would be going to the moon again, and they got crushed.”
The difference between then and now is we have a CPI over 8%.
The Fed has inflated an everything bubble. Since 2008, the central bank has pumped over $8 trillion into the economy. It got away with this inflation for a long time because most of that money wasn’t getting to consumers. Instead, we saw asset prices spike – particularly the stock market and real estate.
The Fed tried to normalize rates in 2018 and the air started coming out of those bubbles. It had already pivoted back to rate cuts and QE long before COVID. In a sense, the pandemic saved the Fed’s bacon. It gave the central bank an excuse to pump trillions of dollars in new liquidity into the economy and reinflate the bubbles. But the extent of the quantitative easing and the fact that the government handed out trillions to consumers changed the dynamics. Suddenly, the inflation started showing up in the CPI.
The Fed denied it for months, calling inflation “transitory.” But once it became impossible to deny, it launched its inflation fight. Predictably, the markets tanked until they decided the Fed was about finished tightening. Now, reality has set in again and we’re back to the bear market.
WolfStreet sums it up.
“These artificially inflated markets cannot even maintain their level amid rate hikes and QT. Even little-bitty rate hikes, just four in a year, and small amounts of QT caused markets to tank, just like interest rate repression and QE had caused them to soar. It was becoming clear to everyone: QT was having the opposite effect of QE.”
The question remains: what will the Fed do. Will it hold the course? Or will it do what it has done in the past — pivot back to inflationary, loose monetary policy to rescue the economy, as it did after the dot-com bust (setting up the 2008 financial crisis).
WolfStreet argues that there will be no Fed pivot. He thinks the central bankers will be willing to tank the economy to get inflation back to 2%, just as Jerome Powell promises.
“There have been lots of people who said that the Fed will keep doing QT “until something breaks.” Last time it did QT until the repo market broke. That was when the banks stopped lending to the repo market, which then blew out, which cause the Fed to bail it out in September 2019.
“But this time, the biggest thing that the Fed is in charge of has already broken: price stability. Inflation is the worst it has been in 40 years. And the Fed is tightening in order to fix this huge thing that has broken – to bring this inflation back under control and down to 2% (as per core PCE). This could be a long and tough slog. And other things that might break along the way are by comparison just minor inconveniences.”
This is where I part ways with WolfStreet’s analysis. I think the things that break will be far more and “minor inconveniences.”
Just consider the impact on the national debt. When you run the numbers, it becomes clear the US government can’t operate in a high interest rate environment. And the US government isn’t alone under a big pile of debt. Corporations are overleveraged and consumer debt is at record levels.
So far, the Fed has stayed resolute to follow through with its inflation fight. Peter Schiff said the Fed still thinks it can do the impossible, and it will ultimately pivot. But not until it can no longer deny the impacts of its tighter monetary policy.
“I think when Powell is really confronted with how ugly this is going to be, then we’re finally going to get that pivot. But this is a giant game of chicken, and I think Powell is going to keep up this pretense as long as he possibly can.”
The mainstream has conceded a recession looms, although most people say it will be short and shallow. But as Peter Schiff said, the bust needs to be proportional to the boom.
“We’ve never had a boom this big. We’ve never had interest rates this low for this long. We’ve never had an economy more screwed up than the one we have right now. We’ve never had bigger asset bubbles, bigger debt bubbles, more misallocations of capital and resources. So, we have more mistakes that we need to fix now than ever before. So, how are we going to do that with a short shallow recession? We’re not. It’s going to be a massive recession. And again, the Fed has no stomach for that, and that’s why the Fed is going to pivot.”
Alan Greenspan was able to engineer a recovery after the dot-com bust with some rate cuts. Ben Bernanke was able to engineer a recovery after 2008 with rate cuts and QE. (And by recovery, I mean reinflate the bubbles.) But they didn’t have to contend with 8.3% CPI. Jerome Powell does. And that changes everything.