In our 1/2/18 post “2018” we suggested that the only group that could supply new funds to push the stock market higher was the public at large. The figures for December and January are in they show this group’s participation was the greatest since the “Great Recession.” They bought pushing the market to the stratosphere. Unfortunately, with no more new money available, the market was set up for a change of direction. The reason given for the subsequent sharp down move was rising interest rates. The bulls argue the market hadn’t had a correction for an abnormally long time and was overdue. In any case interest rates are historically low. Even the recent rise and the projected Federal Reserve moves should be easily handled by worldwide growth. After all, economic expansions in the past faced much higher rates and still thrived. In the US profits will be greatly enhanced by the recent tax revisions. Wages and optimism are rising. Solid reasons for expecting the economic expansion to continue accompanied by rising profits. This should be reflected in higher stock prices.
On the surface this makes a lot of sense but what if the recent interest rate rise even from such low levels is indicative of a much more dangerous situation? In our series the Long Journey to “More” the post Free Capital to Finance “More” attempted to show how the world’s central banks led by our Federal Reserve had caused massive distortions to the traditional risk pyramid. Instead of a base of relatively safe assets tapering up to high risk, we had a pyramid of mostly risky assets. With so much risk already, investors might really be reluctant to go after the really high risk/high reward ventures. We thought this might help explain the tepid growth throughout the era worldwide “Quantitative Easing.” The theory behind the central bankers move to zero or negative interest rates was to drive up the value of risk assets giving their owners gains resulting in a “wealth effect.” This would result rise in greater consumption driving growth. Some economists claim this indeed added to growing GDPs. The consensus in the US is that it added about 1/2% to our GDP. Even granting this might be true, it has left investors far and wide with horribly unbalanced portfolios. Across the board they’re out of line with normal risk tolerance.