The Last Time They Did This...

In mid-December, 2015, the US Fed raised interest rates for the first time since 2006.  The day this happened, the S&P was at 2073. Seven weeks later, it was at 1829. That equated to a 12% drop in a month and a half.

There is a debate underway around the possible effects of rising interest rates. Here it is...

One side holds that the markets have nothing to do with the massive economic stimulus that was unleashed by governments and central banks world-wide after 2008. The markets reflect real economic growth, and are a rational reflection of normal economic activity.

The other side believes that the markets are a Ponzi scheme. They are elevated only because of the economic stimulus, especially the era of free money that was ushered in by central banks, especially the US Fed.  Once this era ends, the markets will essentially collapse, as the economic activity that we have witnessed since 2008 is similarly a mirage.

Both sides have compelling arguments to make. Which side is right?  Here is what we know.

The stimulus that has been unleashed since 2008 has been unprecedented in peace-time. It has not had the economic effect it was supposed to have had, and has been a failure in many respects.

Quantitative Easing, for example, was supposed to launch $4.05 Trillion into the US economy in three phases as the US Fed bought US Treasuries and mortgage-backed securities from US banks, that then lend the cash into the economy. Had that actually happened, the US economy would have exploded - and inflation with it. In fact, only about $1.5 Trillion of that money ever made it into the US economy, and almost all during QE1. The effect as the best economic growth since the Great Recession, but that was in 2010. It is now 2016, and the US economy has not seen a significant up-tick in growth since. US banks still have about $2.4 Trillion of QE cash on deposit with the US Fed.

The US government borrowed and spent trillions of dollars in 2008 - 2012. This also made it into the US economy.  In previous recessions, the result of spending like this would have been massive growth - well above 5%. Again, this simply has not happened this time.  

The QE and borrow and spend policies have been mirrored in Europe, Japan and China. Nowhere has there been really significant new growth. Japan is still in recession, Europe is anaemic, and even China is slowing.

And so, for those who argue that the markets reflect real growth since 2008....where is this significant new growth?

The other side of the debate my be too negative - it ignores that there has actually been been some growth since 2008, and we have not actually been in a world-wide technical recession in years. The markets should be higher than they were in 2008 - 2009. The question is...how high?

Well, I don't know; no one does.

What I do know is that the last time the US Fed raised rates, the markets pulled back in double-digit percentages world-wide, and last week the US Fed hinted at another rate hike next month.

Is it hard to figure out what will most likely happen immediately after that?    




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