{"id":191875,"date":"2023-06-12T12:45:00","date_gmt":"2023-06-12T16:45:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=191875"},"modified":"2023-06-12T13:04:28","modified_gmt":"2023-06-12T17:04:28","slug":"the-asymmetries-of-fear-greed-and-monetary-policy","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/stocks\/the-asymmetries-of-fear-greed-and-monetary-policy\/","title":{"rendered":"The Asymmetries of Fear, Greed and Monetary Policy"},"content":{"rendered":"\n<p>There is an old saying that stocks take the stairs to the roof but the elevator to the basement.&nbsp; As with many market adages, it\u2019s not exactly true, but there is sound behavioral logic behind it.&nbsp; When equity markets rally, they tend to grind higher.&nbsp; When they plunge, they do it quickly.&nbsp; At those times, fear tends to be a more visceral motivator for stock traders than greed.&nbsp; Yet the opposite is the case when monetary policy changes.&nbsp; Liquidity injections quickly boost the stock market, while restrictive policies can take months to work their way into valuations.&nbsp; Greed outweighs fear in that case.&nbsp; Let\u2019s examine why.<\/p>\n\n\n\n<p>The key factor is the elusive concept of momentum.&nbsp; From the perspective of basic physics, <a href=\"https:\/\/en.wikipedia.org\/wiki\/Momentum#Newtonian\">momentum is defined as <strong>p=mv<\/strong><\/a>; momentum (p) is the product of mass times velocity.&nbsp; Momentum plays a key role in <a href=\"https:\/\/en.wikipedia.org\/wiki\/Newton%27s_laws_of_motion#Newton's_second_law\">Newton\u2019s Second Law of Motion<\/a>, which states: \u201cwhen a body is acted upon by a force, the time rate of change of its momentum equals the force.\u201d&nbsp; Unfortunately, the market\u2019s definition of momentum is not as neat as a physicist\u2019s.&nbsp;<\/p>\n\n\n\n<p>It is quite clear that when market forces are greater, so is the speed of the ensuing move.&nbsp; But in common investment parlance, momentum is generally conflated with trendiness.&nbsp; I assert that momentum has more in common with <a href=\"https:\/\/en.wikipedia.org\/wiki\/Newton%27s_laws_of_motion#Newton's_second_law\">Newton\u2019s First Law<\/a>, which expresses the principle of inertia as: \u201cA body remains at rest, or in motion at a constant speed in a straight line, unless acted upon by a force.\u201d&nbsp; Quite frankly it is much more exciting to discuss market trends as being a product of momentum rather than inertia.&nbsp; How many investors would prefer to label their trend following strategies as inertia-based, rather than momentum-based?<\/p>\n\n\n\n<p>Regardless of terminology \u2013 momentum or inertia \u2013 we know that markets and economies tend to trend in one direction or another for periods of time.&nbsp; The relative persistence of those trends, and the forces required to alter their course, are the crux of the differences in policy reactions.<\/p>\n\n\n\n<p>We have all heard that monetary policy operates with \u201c<a href=\"https:\/\/www.stlouisfed.org\/publications\/regional-economist\/2023\/may\/examining-long-variable-lags-monetary-policy\">long and variable lags<\/a>.\u201d &nbsp;Unfortunately, there is little consensus to how long and variable those lags may be.&nbsp; It can take months, if not years, for central bankers to tamp down inflationary expectations.&nbsp; Once they become embedded into either the public\u2019s psyche and\/or baked into contracts that adjust with changes in CPI, inflationary expectations become difficult to dislodge. &nbsp;<\/p>\n\n\n\n<p>Even though inflation is at root a monetary phenomenon \u2013 too much money chasing too few goods and services \u2013 it has an important psychological component.&nbsp; The tools at a central bank\u2019s disposal \u2013 interest rates and quantitative easing\/tightening \u2013 have at best and indirect effect on psychology.&nbsp; Tighter credit eventually works its way through the economy, but only after it takes its toll on interest rate sensitive sectors and the availability of credit.&nbsp; Eventually those take their toll on corporate earnings, employment, and psychology \u2013 but over the course of the \u201clong and variable lag.\u201d<\/p>\n\n\n\n<p>On the other hand, markets are innately attuned to positive changes in monetary supply.&nbsp;&nbsp; Consider the following two graphs.&nbsp; The first shows the size of the Federal Reserve\u2019s balance sheet and the value of securities that it holds.&nbsp; We see that both grew sharply in rough lockstep during the post-Covid response, and until March, both began to fall as quantitative tightening (QT) replaced quantitative easing:<\/p>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"916\" height=\"637\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture2-4.png\" alt=\"Federal Reserve Balance Sheet \" class=\"wp-image-191879 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture2-4.png 916w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture2-4-700x487.png 700w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture2-4-300x209.png 300w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture2-4-768x534.png 768w\" data-sizes=\"(max-width: 916px) 100vw, 916px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 916px; aspect-ratio: 916\/637;\" \/><\/figure>\n\n\n\n<p><em>Source: <\/em><a href=\"https:\/\/www.federalreserve.gov\/releases\/h41\/\"><em>Federal Reserve H.4.1 reports<\/em><\/a><em>, Interactive Brokers<\/em><\/p>\n\n\n\n<p>The bump in March occurred as the result of the Fed\u2019s actions in response to the sequential banking collapses that we saw at that time.&nbsp; The Fed lent about $300 billion to various banks to shore up the system and those loans show up as assets on the Fed\u2019s balance sheet.&nbsp; By stemming the crisis, they restored confidence to a suddenly fragile banking system \u2013 no complaints about that \u2013 but the balance sheet expansion provided a bit of a sugar rush to equites.&nbsp;<\/p>\n\n\n\n<p>The following chart shows the performance of the S&amp;P 500 Index (SPX) over the past six months.&nbsp; The dip in early March shows how quickly stocks respond negatively to a potential crisis.&nbsp; The rebound was quick and sensible when it became apparent that the contagion was limited, largely thanks to the monetary backstop.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-spx-6-month-chart-daily-bars\"><strong><em>SPX 6-Month Chart, Daily Bars<\/em><\/strong><\/h3>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"624\" height=\"410\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture1-16.png\" alt=\"SPX 6-Month Chart, Daily Bars\" class=\"wp-image-191878 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture1-16.png 624w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/06\/Picture1-16-300x197.png 300w\" data-sizes=\"(max-width: 624px) 100vw, 624px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 624px; aspect-ratio: 624\/410;\" \/><\/figure>\n\n\n\n<p><em>Source: Interactive Brokers<\/em><\/p>\n\n\n\n<p>One can assert, however that the subsequent rally, however, can be a testament to the positive momentum that the brief financial accommodation engendered and to the asymmetry of markets\u2019 responses to changes in monetary policy.&nbsp; Even though the Fed\u2019s balance sheet has shrunken to pre-crisis levels, stocks have certainly not.&nbsp;<\/p>\n\n\n\n<p>We all know the importance of another key market adage \u2013 \u201cdon\u2019t fight the Fed.\u201d&nbsp; But the speed at which a Fed move inspires fight or flight depends almost entirely upon the type of monetary policy that we face.&nbsp; If it\u2019s accommodative \u2013 even in response to a crisis \u2013 the response tends to be quick and thorough.&nbsp; If it\u2019s restrictive, the lags tend to be long and variable.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>There is an old saying that stocks take the stairs to the roof but the elevator to the basement.  As with many market adages, it\u2019s not exactly true, but there is sound behavioral logic behind it.  <\/p>\n","protected":false},"author":4,"featured_media":182829,"comment_status":"open","ping_status":"closed","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[14700,6,8,9,22,26,3],"tags":[2542,1504,4109],"contributors-categories":[13576],"class_list":{"0":"post-191875","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-ibkr-market-insights","8":"category-north-america","9":"category-region","10":"category-securities","11":"category-stocks","12":"category-text-articles","13":"category-traders-insight","14":"tag-market-impact","15":"tag-monetary-policy","16":"tag-stock-market","17":"contributors-categories-interactive-brokers"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v26.9 (Yoast SEO v27.7) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>The Asymmetries of Fear, Greed and Monetary Policy<\/title>\n<meta name=\"description\" content=\"There is an old saying that stocks take the stairs to the roof but the elevator to the basement. 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As with many market adages, it\u2019s not exactly true, but there is sound behavioral logic behind it.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/the-asymmetries-of-fear-greed-and-monetary-policy\/\" \/>\n<meta property=\"og:site_name\" content=\"IBKR Campus US\" \/>\n<meta property=\"article:published_time\" content=\"2023-06-12T16:45:00+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2023-06-12T17:04:28+00:00\" \/>\n<meta property=\"og:image\" content=\"https:\/\/www.interactivebrokers.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/02\/yield_curve_confused_featured-img.jpg\" \/>\n\t<meta property=\"og:image:width\" content=\"1000\" \/>\n\t<meta property=\"og:image:height\" content=\"563\" \/>\n\t<meta property=\"og:image:type\" content=\"image\/jpeg\" \/>\n<meta name=\"author\" content=\"Steve Sosnick\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" 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