A ‘Powell put’ is not guaranteed for the markets

Everybody is waiting for Jay Powell, the new Fed Chair, to set out his vision this week. The main question is: will there be a “Powell Put” just as there has been a Greenspan put, a Bernanke put and a Yellen put?

It certainly has a ring to it. Say it out loud, and it sounds even better than the previous ones. Alliteration usually has that effect.

Powell kicks off his semi-annual testimony to the US Congress on Tuesday, and is expected to speak about the dollar, the economy, inflation, unemployment, the usual things. Just as he took over from Janet Yellen at the helm of the Fed, markets have lost around 10% of their value.

Someone like Yellen or Bernanke would have probably, by now, used an opportunity to say something to try to calm investors. But all that Powell has managed was a bland statement about remaining “alert” to risks to financial stability.

If that’s all he’s got on the issue — and we’ll see if that’s the case soon enough — investors should definitely get used to an era when the punch bowl is, if still left on the table, no longer replenished.

One of the explanations for why stock markets sold off has been that investors are worried that as yields increase due to the lack of Fed buying and rising interest rates, money will leave equities and seek safer returns in bonds.

This may be so, but if we look at how much money each asset class took since quantitative easing started in 2008 at the height of the global financial crisis, it’s not equities that took the bulk of the cash. So there’s a lower limit to how much money will end up leaving stocks.

Global equity mutual funds and exchange traded funds (ETFs) took in $899 billion between 2008 and 2017, according to data from TrimTabs Investment Research. Bond mutual funds and ETFs received $1.88 trillion in that period.

But questions were beginning to be raised about how much money people were willing to throw at assets that gave them negative yield returns.

In the period after the financial crisis, the difference between fixed income and equities was blurred; investors increasingly relied on bonds for capital appreciation, rather than for the income they offered. This was easy while central banks offered traders a one-way bet.

However, ultimately bonds risked becoming victims of their own success: as central banks kept buying them to push rates even lower, it was increasingly obvious the asset class offers “unnatural” price returns.

At some point, confidence in the “safety” of government bonds would have collapsed and a massive selloff could have ensued, even if central banks were to keep buying them. In a fight between markets and governments, markets usually win, even if it takes them a long time to do so. History is full of examples of hyperinflation-ridded countries that prove this.

Perhaps we were not too close to the point of collapse yet, or perhaps Jay Powell is not too worried about that. We will hear more once he sets out his vision for the Fed in his first testimony to Congress since the start of his mandate.

But if this is the first time in decades that markets will have to survive without the Fed put, some interesting times are ahead.

P.S. If you are wondering what the Bank of America Merrill Lynch Bear/Bull indicator says, it’s still stuck at Sell (for those who want exact numbers, that’s a value of 8.2).