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Talk Markets: Charting the Stock Market 'Melt Up,' And the Fed's Naivety

November 08, 2021
Market Bubble Crash

Article By Lance Roberts in Talk Markets

Charting the stock market “melt-up” in prices, and the Fed’s naivety of the laws of physics may be of benefit to younger investors. After more than a decade of rising prices, accelerating markets seem entirely normal, detached from underlying fundamentals. As a result, new acronyms like “TINA” and “BTFD” get developed to rationalize surging prices.

However, a more extended look at price history suggests the current market environment is anything but typical. More importantly, the “moral hazard” created by the Federal Reserve’s continuous bailouts has put individual investors at significant risk.

A Long History of Poor Outcomes

In the short term, like above, charting stock market prices may not seem extraordinarily stretched. However, this is because the chart lacks context from a historical perspective. Once we look at the market from 1900 to the present, a different picture emerges compared to its exponential long-term growth trend.

What you should take away from the chart above is apparent. Investing capital when prices are exceedingly above the underlying growth trend repeatedly had poor outcomes. Investing money at peak deviations led to very long periods of ZERO returns on capital. (Interestingly, as the Fed became active in the markets, the periods of zero returns got cut in half.)

Timing Is Everything

Investors are remiss to dismiss the importance of the long periods of zero returns.

More often than not, the consistently bullish advisory and media crowd present long-term studies to support investing in markets. Generally, these studies get presented without context to coerce you into buying their products or using their services. I recently showed an example of such a study:

While well-meaning, there are several critical points with such analysis. Let’s review the long-term chart above.

  • When charting stock market prices or returns, cherry-picked start dates can provide any result you want.
  • For example, 100-years ago was 1920. That was the beginning of a significant bull market cycle that lasted until 1929.
  • However, back up 20-years to 1900, an investor had to wait until the 1950s to break even.
  • Starting 25-years ago was 1995. While the run from 1995-2000 was solid, investors spent the next 13-years going nowhere.

Given that we don’t live forever and have a finite time frame to save for retirement, “when” you start your investing journey is critically important.

As the old saying goes, “timing is everything.”

Ignoring The Laws of Physics

Interestingly, in the July FOMC minutes, the Fed made mention of market valuations. However, while they may acknowledge that valuations have become elevated, they fail to understand the laws of physics.

As noted, extreme deviations above the long-term growth trend will eventually revert to the mean. In the 60s and 70s, it took nearly 15-years of rolling tops and bear markets to complete the reversion. It took almost 9-years to complete the reversion at the turn of the century.

The problem facing the Fed is the diminishing impact of QE on the financial markets. As noted previously, it requires ever greater levels of monetary intervention to lift asset prices. As a result, when the reversion to mean ultimately begins, the Fed may not be able to arrest the decline as quickly as they did in 2020.

There is more than adequate evidence a “bubble” exists in markets once again.

‘I have no idea whether the stock market is actually forming a bubble that’s about to break. But I do know that many bulls are fooling themselves when they think a bubble can’t happen when there is such widespread concern. In fact, one of the distinguishing characteristics of a bubble is just that.

“It’s important for all of us to be aware of this bubble psychology, but especially if you’re a retiree or a near-retiree. That’s because .......

To read this article in Talk Markets in its entirety and view the relating charts, click here.

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