Fed Easings and Market Tops

From Jack McHugh comes this observation about the nature of market tops and Fed easings:

"There have now been 3 hair-raising instances in the past 20 years when the capital markets broke down badly enough to cause commercial and investment banks alike to stare into the abyss of total collapse. In each case, the stock market fell after hitting recent new highs and the Fed came riding to the rescue. 

Here are those periods, the amount of the decline in the S&P off the highs, and how many days after those highs were seen for the Fed to take action:

October, 1987; decline of 40% off August highs;
Fed eased less than 60
days after the top

September, 1998; decline of 20% off July highs;
Fed eased less than
60 days after the top

August, 2007; decline of 10% off July highs;
Fed eased less than 30 days after the top on July 19   

** I’ve excluded September 11, 2001; the fear was of a different nature and Fed was already easing**

Notice any pattern developing? Yes, the times are shortening between stock market tops and the first Fed ease. And, yes, the amount of decline in the S&P before the Fed pulled the trigger has dropped significantly, from -40%
in 1987 to a mere -10% today.

Why would the Fed see fit to ease so shortly (less than a month!) after an all time high in the S&P? Saying it’s simply Ben Bernanke’s "helicopter" mentality is as unfair as it is facile.

Part of the explanation is that the equity crowd is the biggest beneficiary of a credit bubble, and that they are the last in the room to understand why its unwinding matters to them. The more important reason has to do with the rise of securitization’s role in the capital markets.


Good stuff. Thanks, Jack.

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  1. Florida commented on Aug 21

    My fear is that as the time frame between a top (if that is what we just saw) and Fed intervention shortens, and the percentage of correction allowed shrinks, the Fed ultimately is just encouraging ever riskier endeavors over the long term, as market players price in the Fed saving them in the end.

  2. michael schumacher commented on Aug 21

    >>. Why would
    the Fed see fit to ease so shortly (less than a month!) after an all time high in the S&P? >>

    If you pushed it up there….you’re going to know what the top, or close to it, is. If you did’nt have control of it then you would naturally wait to see if it were truly a top. , like in 1987….

    It’s all a carefully orchestrated ballet to influence the elections…..however (like in Iraq) the people in charge are just so brazen and ignorant they really have no clue what it’s like in the world of reality (where the voters live). So what we will have is a hand-off to the democrats so that they can be fully in charge when the shit hits the fan…..just like Carter.

    economic indicators? we don’t need those
    credit? Nah…not important
    losses? Not on my watch-GWB


  3. wally commented on Aug 21

    Or… the Fed is not even looking at the market levels – just at the credit picture. In that case, there is coincidence but not a direct relationship.

  4. Jay Weinstein commented on Aug 21

    I would like to point out, as of this typing, that the S&P 500 is down less than 1% for the month of August. So wtp?

  5. michael schumacher commented on Aug 21


    tell that to Paulsen and Bernancke………they seem to not realize that.


  6. SPECTRE of Deflation commented on Aug 21

    According to Lacker, who spoke very plainly for the FED, a FFR cut is not needed at this time. The FED understands there will be a repricing of risk, and will do very little in the way of helping the players. The FED believes the economy still has growth left in it, and they are concentrating on it and inflation.

    How much plainer can they make it for the so called smart money? Sink or swim boys and girls.

  7. SPECTRE of Deflation commented on Aug 21

    CNBS talking bailout right now. How about we hold those responsible for this debacle to fix the problem? Everyone is now a victim. Nevermind that you make 35K a year, yet you buy a 750K house on a pure speculation play. Now you become the poor homeowner. Only in America folks.

  8. SPECTRE of Deflation commented on Aug 21

    Let’s all call the credit card companies, and let them know we poor sould were all confused by the terms of the cards. I mean Hell if we are going to bail, why not everyone because we are all too stupid to understand legal documents. We are victims I tell ya!

  9. sn commented on Aug 21

    So, what is the risk in buying equities now? Even a modest decline will be met with howls and screams of protest and a Fed galloping to the rescue. The pool temperature seems fine.

  10. shoeless commented on Aug 21

    I think Lacker’s comments should be looked at very carefully. If the FED is serious about letting risk reprice, then equities are in for trouble. Lacker also said that market volatilty is not the barometer the FED is using to determine the need for a possible cut.

    But be sure and take all this with a grain of salt, as it seemed that Poole was speaking for the FED just last week and got steamrolled less than 48 hours later.

  11. Josh commented on Aug 21

    But the Fed didn’t ease yet. Just an easing on the discount window. That doesn’t affect anything.

    Gartman says today they will ease in September and start the cycle down.

    We’re getting quite a few fear mongers here. I wish Fred would come back and provide some balance.

  12. dukeb commented on Aug 21

    The risk in buying equities now could be that the hedgies are playing chicken & lobbying hard in the hopes that the Fed takes more action, stock prices surge, and then the hedgies can make all of the necessary sales at “fair market value” for those redemption requests they’re sitting on. –Just one of the myriad ways the common man can get played when prices detach from the companies against which they are supposedly issued.

  13. Groty commented on Aug 21

    A banks worst nightmare is for the commercial paper market to stop functioning. The banks offer CP backup lines when times are dandy and believe the lines will never be drawn. So when CP investors fail to allow CP issuers to roll their CP, the issuer draws down against a CP facility.

    The banks freak out because they correctly perceive the issuer’s failure to roll CP as CP investors no longer wanting the risk. The CP investors are shifting that risk to the banks. So the banks suddenly find themselves lending money against a facility they never really expected would be drawn AND the underlying credit conditions have changed adversely so the CP facility pricing doesn’t reflect the current perceived credit risk of the issuer.

    The banks respond by tightening conditons across the entire credit spectrum. And if credit creation slows, so will the economy. So, in my opinion, if the CP market doesn’t start functioning more normally, then the FED will lower the FF rate dramatically and in very short order. Not to bail anyone out, but to prevent a recession created by a slowdown in credit creation.

  14. VJ commented on Aug 21

    the amount of decline in the S&P before the Fed pulled the trigger has dropped significantly, from -40% in 1987 to a mere -10% today. Why would the Fed see fit to ease so shortly (less than a month!) after an all time high in the S&P?

    Because the S&P was already down 18% from where it was in 2000 in inflation adjusted dollars, BEFORE that 10% decline. During the previous declines, the stock market had been rising faster that the underlying inflation rate.

  15. SPECTRE of Deflation commented on Aug 21

    Not to be left out, we have a liquidity problem in Merry Old England:

    Borrower draws on BoE emergency loan
    By Stacy-Marie Ishmael and Gillian Tett

    Published: August 21 2007 12:01 | Last updated: August 21 2007 12:01

    The Bank of England said it made an emergency £314m loan to an unidentified party on Monday through its standing facility, which allows banks to borrow unlimited amounts at a penalty rate of 6.75 per cent.

    The UK base rate is 5.75 per cent. It is the first time the facility has been tapped since the onset of the liquidity crisis in financial markets, the Bank said.

    A spokesman for Northern Rock, which has been at the centre of liquidity concerns, said it had not used the facility.

    The BoE’s move is likely to attract intense interest, given the current level of market anxiety, and could provoke speculation about why any borrower would choose to fund itself at a rate above the prevailing market levels.

    In particular, there is widespread debate in the financial world about the degree to which funding problems in the commercial paper market may be creating liquidity challenges at banks.

    ”This isn’t necessarily a huge deal. If we weren’t in this sort of market environment, this wouldn’t have raised the level of interest that it has,” Tom Jenkins, banking and financials analyst at the Royal Bank of Scotland. ”It’s interesting that it happened at this point, but it doesn’t automatically suggest there is a wider crisis in the making.”

    The Bank has always stressed in its monetary policy framework that it does not wish the market to consider the use of the standing facility to carry a stigma, and banks have tapped the window on a fairly regular basis in the past when they have faced short-term issues in their liquidity management.

    The Bank’s framework has hitherto contrasted with the monetary system in the US, where the use of the window has traditionally carried such a high stigma that banks have gone to great lengths to avoid using it.

    While other major central banks – including the European Central Bank and the US Federal Reserve – have acted to inject liquidity into the financial system to ease lending conditions, the Bank of England has so far not intervened by taking any unusual measures.

    However, the standing facility is open to any participants in the market, if they require them, and officials at the Bank have drawn up a list of additional measures that they may implement if the overnight rate in the sterling money markets remains high for an extended period.

  16. techy2468 commented on Aug 21

    sorry for repeating myself, but why is it so hard to understand what current administration in every country want.

    if USA stock market falls…its a clear signal of slowing economy…consumer stops spending…business stops spending and stops hiring…..there we have a recession. (am i right?)

    if USA goes into recession…..China goes into depression….so does india (and maybe all emerging economies dependent on usa consumers)

    so i am assuming that everyone in the world….including our own GWB are going to try their best to postpone recession as long as it is possible (not on their watch).

  17. techy2468 commented on Aug 21

    Off Topic:

    if i remember it right….buffett and gates foundation was buying homebuilder stock back in Jan/Feb 2007 thinking that they were cheap..

    right now i saw a news that buffett is buying countrywide, and its share [price has gone up 10%

    anyone has insight into this??

  18. John Thompson commented on Aug 21

    Time for a paradigm shift in American manufacturing. But I guess that comes after the collapse next year?

  19. Turbo commented on Aug 21

    The comparison to 1998 is real, but to 1987 is superficial at best (so far at least). Anyone working on a bank, fund or corporate money market desk knows this has nothing to do with equities, and if those touting equity bargains paid attention to how utterly dysfunctional the wholesale lending markets have become, I think you’d get your down 20%+ comparisons. Besides, the Fed has so far acted only to provide temporary liquidity – cutting the discount rate and expanding repo operations is not a rate cut.

  20. michael schumacher commented on Aug 21

    We are already in a recession……you think the dept. of commerce is going to release ANY information that hints at it? No.. recessions are not talked about until they are well into there own cycle. So..with that in mind then we will begin to hear about the recession we are in.. say about the end of November 2008 ;-)

    Just like last time..except we had a little side show called a contested election that allowed the recession to be full blown just before Bush “won”……neat how it’s about to happen all over again.


  21. Jay Weinstein commented on Aug 21

    Here’s one for the conspiracy guys:

    The danger in the Fed lowering rates is a dollar crash and higher future inflation.

    But as we saw from 2002-6, there is no inflation from low rates! [tongue in cheek]

    So lower away boys! LOL

    Also, groty is right about CP in my opinion. There are SIGNIFICANT withdrawals from money from money funds to treasuries. There is a system shutdown problem if that happens—it is a modern run on the bank….

  22. Justin L Tindall commented on Aug 21

    Look at the historical chart people, we are do, I would suggest “in need” of a recession has everyone forgotten that the pendelum swings both ways?

  23. Fred commented on Aug 21

    The Fed could care less about the stock market. (Joe six pack isn’t even involved yet).

    The Fed has its eyes squarely on the frozen ABCP (and CP) market(s). This will be orchestrated brilliantly. They’ll cut the FFR and the DR, which will also bring down the Prime Rate (luckily for the resets). This will also be timed with a few key Corp debt offerings THAT WILL BE OVERSUBSCRIBED. That will mark the turn to a more liquid capital markets.

  24. Chris M commented on Aug 21

    As James Bednar points out, the Fed has already been easing, as of 8/10. The Fed Funds rate is a market rate, which yesterday was 5.03%. If the Fed cuts the target rate to 5.00%, it won’t effect the current Fed rate because it is already around 5.00%. Unless the Fed does another stealth rate cut.

  25. Aaron commented on Aug 21

    This is an interesting argument. Some people think the Fed is making moves mainly based on the equities market, while others believe the Fed is simply looking at the credit markets. I think it is tough to tell until we hear the full statements in September.

  26. SPECTRE of Deflation commented on Aug 21

    Off Topic:

    if i remember it right….buffett and gates foundation was buying homebuilder stock back in Jan/Feb 2007 thinking that they were cheap..

    right now i saw a news that buffett is buying countrywide, and its share [price has gone up 10%

    anyone has insight into this??

    Posted by: techy2468 | Aug 21, 2007 2:02:22 PM

    The part you didn’t hear was that they later sold them for a tidy profit, the stocks ramped after the Gates /Buffet announcement, without telling anyone about it. Real character.

  27. Bullion commented on Aug 21

    I just don´t understand the purpose of this article.
    What does it menan in plain english?


  28. Brian H commented on Aug 21

    Perhaps I’m a bit green at this but I don’t see mentioned the crash in 2000? did the FED do anything then? that seems to be a greater loss on the market than 1987.

  29. New Yorker commented on Aug 21

    Joe Sixpack is indeed involved. Did you not notice foreclosures are up everywhere?
    The ARM’s are now killing people. And it has finally hit NYC- foreclosures rose last month 55%.

  30. David commented on Aug 21

    Some reliable sources say a rate cut by the mid-September. Maybe when Maria Bartiromo get back from her vacation.

    Wouldn’t surprise me, it will be interesting to see what happens to the dollar and the China backlash.

    Goldilocks will be saying it to cold, and Bernanke will be saying whos been eating my porridge!

    Why of course, politicians like Senator Dodd’s and other’s who sponsored litigation reform in 1995, which took the funds off the hook for their financial statements, will be sleeping in his bed.

    “But it is no matter. Let Hercules himself do what he may, The cat will mew and dog will have his day.” Hamlet

  31. bob commented on Aug 21

    Regarding the comment that Bernanke doesn’t care about the stock market…

    Then why did he decide to barbecue the shorts on Friday. The timing of his move was not coincidental.

  32. Some Days We Eat the Bear commented on Aug 21

    Sorry Ritholtz, Gartman, Rogers, Farber, and all other doom-and-gloom and betting-against-the-Fed bears but you will lose.

    I’ve placed my bets with Bernanke (the Fed).

    Good luck bears with fighting the Fed!

  33. Shrek commented on Aug 21

    It is amzing to see what has transpired in the last three weeks. This is what Doug Noland has been writing about for years and now it has arrived. The instant credit growth began to slow the flaws began to show up and firms began going out of business like crazy. This is very very serious stuff and the US is facing a situation that it hasnt encountered since the early 70’s. What good are models going to be in this situation? Is this system going to pick up where it left off? No way.

  34. rudy_d commented on Aug 21

    I think a major reason why the Fed is so much more eager to bail out the market is that there’s a lot more riding on it now than there was during those prior periods (more people invested, higher asset values, baby boomers nearing retirement, etc.) There’s also a lot less for the economy to fall back on due to the decline in US manufacturing and real estate. For a lot of people, the stock market is the economy.

  35. Shrek commented on Aug 21

    The entire system is addicted to asset inflation! If I was to extrapolate the last 15 years of economic growth why would I even work! All I would do is borrow and leverage and watch the magic of inflation make me wealthy beyond my wildest dreams. However, markets never make the majority rich. Our whole society is a one way bet on further asset inflation. How many people who own real estate are convinced that their property is going to appreciate faster than the dollar is going to depreciate? I would say a lot. Now everyone is caught. This week the market is staring at an uberdeflationary abyss that shows up as 2.8 percent short term rates. Everyone is caught. How can my friends own a million dollars in real estate when they make less than 100k a year? It would take economic nirvana or unrelentless and continually greater credit expansion to make it work.

    Greenspan blew it badly. He wasnt tough on the markets when he should been and now debt has gone to silly levels. His policy was only cheaper money.

  36. my1ambition commented on Aug 21

    A few points.

    1) Realize that all 3 times mentioned of the Fed’s easing has been done throughout an ongoing bull market. It may even be said that the ease in 1987 and 1998, enabled the bull to run on, making its phenomenal top in 1999-2000.

    Joe Six-pack
    He is indeed involved. He was in on the stock market’s run, the Real Estate speculation and has been running himself deeper into debt since the 70s. It’s a Credit Bubble – Joe is also banking on the Fed to ease.

    Lower-rates: I’m with Mish on the fact that lower rates will only make the situation worse. Even if inflation doesn’t take affect in every currency, it will affect the Dollar. This should explain why Bernanke is so resistant to ease fully.

  37. MikeW commented on Aug 21

    Dr. Bernanke knows very well that we’re damned to the hell of stagflation. Yet
    he seems unwilling to lead us through the

  38. Adam Smith commented on Aug 22

    The Fed should just raise the FFR 100 basis points and get this over with…No better time to break the pattern of moral hazard that the Fed themselves created…

  39. brian commented on Aug 22

    “Dear Mr. Smith……I’LL DO IT!!!”
    -B. Bernanke

  40. klaatu commented on Aug 22

    Dear “Some Days We Eat the Bear”,

    “Don’t fight the Fed?” Let’s take a look at that one.

    Throughout this decade, from 2000-present, you made more money betting against the Fed than with it.

    What happened the first time the Fed cut rates in 2001? The market declined further by 40%. The Fed cut over and over again in 2001. If you went long, you lost money. The market didn’t start to turn around until 2003, after almost 16 rate cuts.

    THEN, what happened when the Fed started hiking rates in 2004? If you “Fought the Fed” by going long into a rate hike, you made money — ALL 16 TIMES.

    When the Fed cuts rates, it’s usually a bad sign — it usually means we’re headed into a recession. When the Fed hikes, it’s usually a good sign — they’re normalizing their policy.

    So you only think you’re “betting with Ben Bernanke”. But Ben Bernanke isn’t betting with you. Will Ben Bernanke make you whole if you lose money?

    Unless your name is Countrywide or Goldman, I kinda doubt it.

  41. Eclectic commented on Aug 22

    Adam and Brian,

    If he did that, he’d have to have face-altering surgery and go into the witness protection program.

    Later, you might go in, say, some grocery store in Albuquerque… and he’s a night shift stocking clerk, or you might find him as a utility meter-reader in Toledo.

    But, wherever they placed him, the Street would find him and extract revenge.

    They’d never find the body… it’d be a bigger mystery than Hoffa.

  42. Eclectic commented on Aug 22

    Some Days:

    It’s been my personal experience that if you’ll whistle a little louder, it won’t seem so scary.

  43. Robert commented on Aug 25

    A weak dollar cuts our national debt and gives the economy an incentive to EXPORT MORE… Yes, it would hurt in the short term, but how else is the US going to get out from under it’s debt? Huh? From where I’m standing, it doesn’t look like govt spending is going to slow down any time soon, soooo…

    I think the FED is going to make a concerted effort, along with other central banks who are holding dollars, to sacrifice the dollar SLOWLY in order to save our economy. Will it work? Probably not… Either way, I think they’re screwed. If they don’t lower rates, the market is going to tank another 10-20%, consumer confidence will plummet, banks’ lending standards will tighten further, the housing market will be CRUSHED, and we will enter a nice, long, extended recession while we get our finances and export/manufacturing sectors in order again.

    Either way, the FED is screwed – Which is why I am heavy in gold stocks. Now if only people would remember that gold is a ‘safe haven’ investment, and it regained it’s negative correlation to the markets…

  44. DB commented on Aug 25

    Maybe the Fed has eased too early, not allowing the market a chance to reach its “equilibrium” as it has in the past, and thus, at the end of the day, the market has a signicant selloff and/or dislocation event, ahead for itself in the very near future….regardless of Fed intervention? (Certainly, if the rally doesn’t hold, and market perception is that the Fed is pushing on a string, the above scenario is more than likely)….IMO

  45. rickrude commented on Aug 26

    Posted by: bob | Aug 21, 2007 8:51:25 PM

    Sorry Ritholtz, Gartman, Rogers, Farber, and all other doom-and-gloom and betting-against-the-Fed bears but you will lose.

    I’ve placed my bets with Bernanke (the Fed).

    Good luck bears with fighting the Fed!

    It is a one sided battle, If the fed chooses to, it can (continue to) print more money.
    The bears(Ridholtz, Faber) have no
    control over the money supply.

  46. rickrude commented on Aug 26

    Posted by: bob | Aug 21, 2007 8:51:25 PM

    Sorry Ritholtz, Gartman, Rogers, Farber, and all other doom-and-gloom and betting-against-the-Fed bears but you will lose.

    I’ve placed my bets with Bernanke (the Fed).

    Good luck bears with fighting the Fed!

    It is a one sided battle, If the fed chooses to, it can (continue to) print more money.
    The bears(Ridholtz, Faber) have no
    control over the money supply.

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