“Don’t Fight the Fed” – Famed Investor Marty Zweig

Dear Clients and Friends,

In August of 1987, after Paul Volker had declined a third term as Fed Chair, President Regan appointed Alan Greenspan as the new Chair of the Federal Reserve. Greenspan would end up serving for almost two decades and oversee one of the greatest Bull markets in our nation’s history. And yet, two months after being appointed as the Fed Chair, Greenspan was tested by the market, which should be an expectation of a newly appointed Fed Chair — the market tests the new leader of the Fed with uncanny regularity.

I don’t exactly know why the markets test Fed Chairs, but I speculate that market participants want to know something about the character of the newly minted leader of the Fed and the only way to cajole this information is to produce a crisis. Good thing Doctors don’t do this with new patients; but the market can be heartless beast that makes participants bend to its will. Think about it this way — the market wants to understand how the Fed will react in a crisis, so the market manufactures an economic battlefield, and the Fed is called upon to be a ‘General’ where they have a handful of weapons to win the battle and the war.

On October 19th of 1987 the Dow Jones Average fell almost 23% in a single trading day (Black Monday), and the set-up for this precipitous drop featured an ‘overvalued market’ near all-time highs, budget and trade deficits that were considered untenable, and a dollar that had been sinking. Does any of this sound familiar? The point of this writing is not to relitigate the 1987 Crash, but to inform the reader that markets have a strange way of testing new Fed Chairs, and it just so happens that a new Fed Chair will be appointed in the Spring of this year.

In the case of Ben Bernanke, who was appointed about a year before the subprime meltdown of 2007, the initial battle was calming a small slice of the credit markets; which was largely unsuccessful. The Battle then spread to a true global credit crises in 2008, where Bernanke pulled out the big guns and eventually won the war. The Fed has to illicit confidence in market participants and if the trust breaks down, contagion spills over into the general economy. This is exactly what happened during the Great Recession of ’07-’08.

The current (and outgoing) Fed Chair, Jerome Powell, faced a volatile sell-off in late 2018 where money markets essentially froze and the credit markets seized for about a month. The market was concerned that Powell would continue to raise rates and squeeze the credit markets too tight causing a credit event. Luckily, ‘General Powell’ decided it was better to sue for peace and stopped raising rates - “The Fed Pivot” as it was called, and after that the market calmed the brewing crises was averted. If you go back and look at these cases and others, I think you will begin to see an outline that is worth following. First, most incoming Feds will be tested by the markets. Second, investors can prepare for these events by monitoring risk building in the system and staying clear of those risky spots. And lastly, the Fed doesn’t always win the battle but does win the war. So, the old adage of not “fighting the fed” will likely remain true this year as we usher in a new Fed Chair, but keep in mind that after we get through the Federal Reserve “red zone” we then have the midterm elections to worry about! Happy New Year!

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