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Why the Fed Can’t Hold the Stock Market Together Much Longer

by Justin Spittler, Casey Research:

Volatility has come storming back…

For the past couple months, the stock market has been eerily quiet. Now, this wasn’t completely unexpected. After all, many traders on Wall Street take off all of August.

But this summer was abnormally calm.

The S&P 500 went 40 days without a 1% move. That was its longest stretch without a big move in decades.

When the market is this quiet, many investors let their guards down. They buy stocks they know are risky. They stop checking their portfolios. They forget to set “stop losses,” which will automatically sell a stock if it starts to tank.

We urged readers to not make these careless mistakes. As we explained on August 25, “periods of extreme calmness have preceded some of history’s biggest selloffs.”

We got a taste of that last week…

• On Friday, U.S. stocks plunged…

The S&P 500 plummeted 2.5%. The Dow fell 2.1%. And the Nasdaq fell 2.5%.

Bonds also tanked on Friday. The yield on the 10-year Treasury jumped from 1.6% to 1.7%. Bond yields rise when bond prices fall.

Yesterday, stocks plummeted again. The S&P 500 ended the day down 1.5%. The Dow and Nasdaq fell 1.4% and 1.1%, respectively.

Today, we’ll tell you what sparked the recent selloff. As you’ll see, the stock market has serious problems that are here to stay. We’ll also show you how to protect yourself for when stocks plunge again.

• Investors are worried what the Federal Reserve’s next move will be…

As you probably know, the Fed launched an unprecedented stimulus program after the financial crisis.

It’s held its key interest rate near zero since 2008. It’s also pumped $3.5 trillion into the financial system.

These radical measures were supposed to stimulate the economy.

They didn’t work. The U.S. economy has grown just 2.1% per year since 2009. That’s less than half the country’s historical growth rate.

While the Fed failed to fix the “real” economy, it did blow a huge bubble in stocks.

The S&P 500 has gained 214% since March 2009. Last month, it set a new all-time high.

• The stock market is now hooked on easy money…

But there’s a problem. Many investors think the Fed could raise rates soon, and that scares many investors. The Wall Street Journal reported yesterday:

Expectations that interest rates would remain lower for longer have helped fuel a rally in a broad range of financial assets in recent months, from U.S. stocks to emerging-market bonds.

Speculation that the Fed could raise rates as soon as next week contributed to a sharp selloff in stocks and government bonds on Friday.

• After Friday’s selloff, the Fed tried to calm investors…

On Monday, three Fed officials said they were in no hurry to hike rates. One official said the Fed needs to have a “serious discussion” about the economy before it lifts rates.

The Fed’s dovish tone was exactly what investors wanted to hear. Reuters reported yesterday:

U.S. stocks led global shares higher on Monday after Federal Reserve policymakers sounded cautious notes on near-term interest rate increases, while the U.S. currency slipped.

To be clear, the Fed was never planning a big rate hike. If the Fed does hike rates, it will only lift its key rate by 0.25%. This would take the Fed’s key rate from about 0.40% to 0.65%. Keep in mind, the Fed’s key rate has averaged 5.0% since 1954.

In other words, it would still be incredibly cheap to borrow money even if the Fed raises rates.

Still, the mere thought of a rate hike terrifies investors. This tells us something is very wrong with the economy.

Of course, that’s not the only reason to be worried about this market…

Read More @ CaseyResearch.com

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