Some market professionals see the frenzied short squeeces in GameStop and other stocks as a sign of bubble formation, but the Federal Reserve doesn’t appear to be, and because of this, investors expect asset prices could continue to rise.
Fed chairman Jerome Powell was asked at his press conference on Wednesday about the potential of Fed policies to fuel bubbles in markets and housing.
Powell stated that the Fed had to use its extraordinary policies to help the economy with more than 9 million unemployed people.
“It is very appropriate that monetary policy be accommodative,” he said. Powell also said on financial stability that the Fed is considering asset prices, leverage in the banking and non-banking systems, and funding risk.
“I would say the overall financial stability vulnerabilities are moderate,” he said. The Fed’s goals are also to prevent long-term damage to the economy and to ensure that the financial system is resilient to shocks. He believes the rise in house prices will be temporary and the pandemic has led to an increase in demand due to people working from home.
“I think he’s hesitant to talk about certain stocks, and even when asked about the real estate market, he feels that part of it is specific to the idea that supply was limited and there was pent-up demand and this is only temporary. ” said Michael Arone, chief marketing strategist at State Street Global Advisors. “I wouldn’t expect the Fed chairman to acknowledge that Fed policies are contributing to bubble creation.”
The Fed’s zero interest rate policy has helped fuel a mortgage boom with record-low lending rates. House prices rose 9.5% year over year in November. This is the strongest annual growth rate in over six years, according to S&P CoreLogic Case-Shiller House Price Indices. This is one of the strongest annual increases in the 30-year history of data.
Shares were lower on Wednesday, with the S&P falling 2.6%, its worst loss in three months. But GameStop continued its parabolic run on Wednesday, gaining 135% that day. AMC gained 300%. GameStop continued to rise on Thursday morning. Retail investors have also bought out of the money call options at record speed.
“A growing majority of investors are unaware of balance sheets, finances, and may be less concerned about the management vision for their businesses,” said Chris Rupkey, chief financial economist at MUFG Union Bank. “They like it because it’s cheap. It’s cheap and they’ll prefer to buy it with options.”
Rupkey said the behavior smells like a bubble and investors only think stocks will go higher. “If the bubble is caused in part by Federal Reserve policies, they are not going to stop spending for some time,” said Rupkey.
When the pandemic hit the markets hard in March of last year, the Fed quickly responded to the unprecedented shock by bringing interest rates to zero and rolling out programs that provided a range of tools to keep financial markets liquid.
The Fed has reversed a credit freeze and stock market crash. Many of the programs are still in place, with the exception of a few that the Finance Department was allowed to phase out in December.
Arone said he was concerned that the Fed made a political mistake this year.
“The less likely mistake is that they are contracting prematurely. I think the more likely mistake is that they bubble up,” he said. “It’s exciting on the way up, but it ends when rates start rising.”
Arone and other equity strategists expected a stock market decline at the beginning of the year after the sharp rise in stocks since November. Any decline would create a buying opportunity as they expect the economy to improve once the vaccine is rolled out and fiscal stimulus kick in – and Fed policies remain supportive.
Arone said it was a warning about bladder behavior. “What’s going on there is a group of Reddit people targeting stocks with a high level of short-term interest. It’s very specific about what’s going on with AMC and what’s going on with GameStop,” he said. “But I think you have this growing investor class of very bold people. You have this interface of technology, zero commissions, and fractions that this investor class that is very aggressive creates, and with those platforms they can be a big group. And that’s it a red flag. “
He said the Fed’s easy rate policy helped stocks. “I think it’s funny when we’re here in 2021 and it really all started after the global financial crisis, maybe even earlier when the Fed manipulated rates of manipulation below growth rates and below inflation rates. It supports asset prices.” he said.
Arone said the Fed and markets also appear to be at odds over whether more stimulus is needed. He said some investors clearly want the Fed to do more, but the Fed is holding back further policy moves, such as changing the maturity of bonds it is buying or increasing their purchases.
“I think behind the scenes the Fed is watching the markets. They are not going to recognize the foam in some of these places,” he said. “But you can be sure that they’ll see what’s going on and they probably don’t want to create another asset price bubble.”
Powell said during the briefing that the recent rise in asset prices was not due to monetary policy, but rather to news about vaccines and fiscal stimulus.
“He overestimated the Fed’s ability to help the economy and underestimated its ability to help markets,” said Peter Boockvar, chief investment strategist at Bleakley Global Advisors. “He continues to distract.”
Boockvar said the Fed’s political repercussions are being felt in all markets, including junk bonds, which have yields at all-time lows and some prices at record highs.
“They are solely focused on the virus and do not care what side effects they are currently experiencing. If they buy $ 80 billion worth of short-term treasuries, how does it result in better economic growth?” he said. “Powell has been so casual about these home price hikes. It’s only temporary. Tell the first buyer who tries to buy a home and keeps getting outbid.”
Rupkey said the Fed is more concerned about other issues and doesn’t see a problem yet.
“This Federal Reserve will not respond to asset prices unless they rise another 100%. This Fed is more concerned than ever about maximum employment,” said Rupkey, “to help those on the edge of the job market.”