Original author: Anthony Pompliano
Original translation: Baihua Blockchain
Optimistic sentiment is spreading in the market, and the flow of capital is also changing accordingly. Adam Kobeissi points out:
"Individual investors' confidence in the market is close to a historical high: 46% of U.S. individual investors believe the likelihood of a market crash in the next six months is less than 10%. This proportion has reached the highest level since June 2006 and has doubled in the past two years (data source: Yale School of Management survey). In other words, investors' concerns about the stock market have fallen to the lowest level in 14 years. Meanwhile, the S&P 500 index has rebounded about 50% since hitting a low in October 2022. However, on the other hand, investors believe that the current market valuation is the most overvalued since the bursting of the Internet bubble in April 2000. Market sentiment is in a state of extreme excitement."
The craziest part of the optimism is that in the long run, optimists are usually right. I think this phenomenon has become increasingly evident in the financial markets, as the Federal Reserve broke the market mechanism about 16 years ago. Since then, we have never truly recovered, and I believe we will never fully recover.
I read a book called "The Lords of Easy Money" by Christopher Leonard over the weekend. This book details the evolution of the Federal Reserve's policies over the past few decades, particularly the rise of quantitative easing (QE) and its profound impact on the markets and financial assets.
From this book, I gained a key conclusion: Over the past fifteen years, economists, investors, and market commentators have made an important mistake - they have focused too much on the price inflation caused by quantitative easing, and have rarely paid attention to the same root cause of asset inflation.
1. Two perspectives on asset inflation
Asset inflation can be viewed from two perspectives:
1) The first view is that asset prices cannot continue to rise indefinitely. If quantitative easing has caused this trend, then the asset bubble will eventually burst.
2) The second view, which contradicts the first, argues that if the central bank is always willing to keep interest rates low and print more money when asset prices fall, then the asset bubble will not burst.
I lean towards the second view. There is strong evidence to suggest that as long as the U.S. dollar remains the fiat currency, the U.S. economy will not experience a bear market lasting more than 18 months again. This may sound bold, but let me explain why.
2. The new normal of current economic policy
Central banks have fully mastered the operation of quantitative easing. They can now cut interest rates and print money at an astonishing pace. For example, during the COVID-19 pandemic outbreak in 2020, the Federal Reserve quickly lowered interest rates to 0% and created trillions of dollars in a short period of time. Although asset prices "collapsed" for a time, they rebounded quickly and reached new highs a few months later.
This is the new "normal" - asset prices seem to be rising forever, which is the optimistic sentiment pervading the market.
3. The new economic reality
For those who grew up in the traditional economic environment before the implementation of quantitative easing policies, this new situation may be confusing. But we have nearly 20 years of data showing that we have entered a completely new economic system.
As Christopher Leonard points out in the book, modern money is no longer true physical money, but is digitally created out of thin air and ultimately distributed to a small number of primary dealers.
This reality has changed all our traditional understandings of the market, inflation, and investment.
Translation: Quantitative easing is actually quite simple, with the core being the creation of large amounts of new money and the injection of funds into the banking system. The goal of this policy is to stimulate economic growth in the absence of savings incentives in the banking system. The Federal Reserve uses a very powerful tool to achieve this goal, which is to connect with a group of major financial traders in New York, who belong to 24 financial companies known as "Primary Dealers", and they are mainly responsible for buying and selling assets.
These primary dealers have special bank safe deposit boxes at the Federal Reserve, called reserve accounts. When the Federal Reserve wants to implement quantitative easing, the traders at the Federal Reserve Bank of New York will contact these primary dealers, such as JPMorgan Chase, and propose to purchase $8 billion worth of Treasuries they hold. JPMorgan Chase will sell these Treasuries to the Federal Reserve traders. Then, the Federal Reserve traders only need to press a few keys to notify the JPMorgan Chase bankers to check their reserve accounts.
In this way, the Federal Reserve instantly creates $8 billion through the reserve accounts to complete this purchase. JPMorgan Chase receives this money and can use it to buy other assets in the market. This is the key way the Federal Reserve creates money: it creates money in the reserve accounts of primary dealers by purchasing assets from them.
In simple terms, this is how the Federal Reserve uses "money creation" to influence the market and stabilize the economy.
If you give someone a printing press, they will definitely start printing money.
And when the Federal Reserve starts printing money, asset prices will continue to rise. This may raise some questions: "What if the Federal Reserve stops printing money?" The analytical perspective may change, but the key to the story is: the United States can no longer afford the consequences of stopping the printing of money. We have become dependent on cheap and abundant funds.
This is why I believe it is almost impossible for a bear market to last more than 18 months. If the Federal Reserve finds that asset prices are falling sharply, they will intervene in the market quickly and strongly.
The market is not completely controlled by the Federal Reserve, but the Federal Reserve acts according to the changes in the market.
In the book "The Lords of Easy Money", the author Christopher Leonard mentions a perfect example to illustrate this point: the Federal Reserve led by Ben Bernanke had planned to implement quantitative easing (QE) on a smaller scale and at a slower pace, but due to concerns that the market's expectations would deviate from the actual actions, leading to a drop in asset prices, Bernanke ultimately had to meet the market's expectations.
So why did I mention this? Because the market optimism I mentioned at the beginning of today is very important, because the Federal Reserve is almost required by the market to intervene in the market and drive up asset prices. The market participants' expectations are like this, so the Federal Reserve has to act.
Now, the market is the real helmsman.
This development means that as an investor, you face a choice. You can choose to believe that the market has gone crazy and a bear market that will last for years is imminent; or you can recognize that the Federal Reserve has broken the stability of the financial market, and they will intervene with stimulative economic measures whenever there are problems in the market, until high inflation is achieved through excessive money printing (and this process will be much longer than most people imagine!).
I am an optimist, and also an observer of history. Just look back at the situation during the global financial crisis (2008), and you will understand that the rules of the game in the market have already changed. The key to investing is not the "timing" of the market, but the length of time you hold the assets.
The bears may sound smart, but the bulls are the real winners.
