The Fed started this rally — and if history is any guide, it will decide when it’s over
In the first nine months and one week of 1999 the Nasdaq rose 30 per cent — pretty solid, but not what you’d call a bubble.
It was on October 7 that the dotcom bubble really got under way. From that day to the end of the year, the Nasdaq rose another 44 per cent in 11 weeks and by the time it peaked on March 9, 2000, it had added 76 per cent, doubling between October 7 and the peak.
October 7 was the day the Federal Reserve announced in its minutes that extra liquidity would be provided to offset what it called “the century date”, also known as Y2K.
The Federal Reserve Bank of New York was directed to buy unspecified amounts of US government securities, which turned out to be a lot.
“The members hoped that the availability of such a system facility would reduce concerns about year-end financial conditions and thus help avert the emergence of the illiquid markets that were feared by an apparently growing number of market participants …”
That Y2K special lending facility flooded the markets with liquidity for six months, in case the world’s computers had a conniption at midnight on December 31, 1999, and ended on April 7, 2000. That week, when it was withdrawn, the Nasdaq crashed 25 per cent.
Fast forward to the present. On September 17 last year, the US overnight money market rate spiked to 10 per cent, raising alarm bells throughout the markets. The Fed immediately began supporting them with extra liquidity, and on October 11 formalised that by announcing that it would buy $US60bn in Treasury bills per month, starting on October 15 and continuing “at least into the second quarter of next year”. It’s become known as “not QE”.
Up to October 11 the S&P 500 had not moved for six months, having risen 17 per cent in the first quarter. From that day on, it took off again and in the three months since has gone up another 17 per cent.
That’s a long way from the Nasdaq’s 76 per cent surge after the Fed’s Y2K funding started in October 1999, but the parallels are striking. Market liquidity tends to flow towards the best returns and in 1999 and in 2019 that was equities, not bonds, and Fed cash has been the oil on waters troubled by trade war.
This is why investors’ No 1 concern right now is not whether the latest US-China trade deal will fall apart, or that the US will go to war with Iran. Rather, the concern is whether the Fed really will end its “not QE” in the second quarter, as it did the Y2K facility in 2000, so that markets will rhyme with that year, as Mark Twain would put it, if not repeat it.
The alternative, rosier, scenario is that 2020 is 2017 again, not 2000.
In 2015 the Shanghai Composite cratered, after spiking 70 per cent in the first half. As the Chinese economy slowed, the Fed was talking monetary tightening, and on December 17 actually increased the Fed funds rate off the 0-0.25 per cent on which it had been sitting for seven years.
As a result, the S&P 500 ended 2015 flat including a 10 per cent correction in August. The ASX 200 fell steadily and ended the year 2 per cent down.
Chairwoman Janet Yellen changed the Fed’s rhetoric in February 2016 and announced a dovish pivot. On virtually the same day, the S&P 500 bottomed. From February 3 to the end of 2016, the S&P 500 rose 17 per cent and the ASX 200 returned 16 per cent.
The US market rally kept going in 2017, supported by the lagged effect of monetary policy and no more rate hikes that year: the S&P 500 returned another 17 per cent in 2017.
The ASX200 underperformed (it was only up 7 per cent) because the banks had a shocker in the lead-up to the royal commission, but the resources index returned 15 per cent and CSL, Australia’s global champion, produced its standard 25 per cent.
Fast forward another year: global markets had an ordinary 2018, with a big correction in the fourth quarter sparked by a hint from Fed chairman Jerome Powell that rate hikes were coming.
With markets in disarray by Christmas 2018 as a result of the Federal Reserve’s tightening bias, and still no sign of inflation in the US, the Fed capitulated and did a dovish pivot, putting rate hikes on hold.
Equities bottomed at the same time.
As a result, 2019 was a stellar year for stockmarkets: the MSCI global accumulation index returned 27.7 per cent, the S&P 500 28.9 per cent and the ASX200 accumulation produced a return of 24 per cent, with the banks once again dragging the local market down.
The Fed’s pivot in 2016 produced a two-year rally and there’s no reason to think the one at the end of 2018 won’t do the same — as long as the punchbowl is not removed in the second quarter, to quote the great 19-year Fed chairman, William McChesney Martin, who famously said the Fed’s job was to take away the punchbowl just as the party gets going, which is what happened in 2000, although arguably the party was well beyond just getting going at that point and was getting messy.
The 2019-20 party is well under way, but not yet messy; stocks are a bit expensive but not wildly so.
Nevertheless, the market’s fate is in the hands of the Fed, and the aphorism “don’t fight the Fed” has never been truer.
Alan Kohler is editor in chief of InvestSMART.com.au
WiseTech, Woolworths lead large-cap gains
When the ASX200 punched through 7000 this week most people thought it was because of the trade deal between China and the US. It wasn’t — it was all about the Fed, and that carries with it a big question: is it 2017 again, or 2000?