What Will You Do if The Stock Market Crashes?

If the stock market crashes it will take the economy and real estate market down with it.

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“All the king’s horses and all the king’s men, couldn’t put Humpty together again” Mother Goose Nursery Rhyme

What Happens when Quantitative Easing doesn’t work or is no longer possible?

Since the stock market crash of 1987 it has been a winning strategy to reinvest in the stock market after each correction. After the October 1987 crash, newly appointed Federal Reserve Chairman Alan Greenspan calmed the markets noting the Fed “stands ready to serve as a source of liquidity to support the economic and financial system’ and the 1987 crash became a temporary blip in the 1980’s bull market.

In 1998 when the collapse of Long Term Capital Management threatened to bring down the markets, Mr. Greenspan arranged for a bailout and the dotcom bubble continued to grow another two years. When the dot com bubble finally burst in early 2000, the Fed once again came to the rescue by lowering interest rates that helped push home and stock prices higher. Mr. Greenspan’s Fed used an interventionist monetary policy so often to prop up the markets that such actions were called the “Greenspan put”.

In 2008 when the housing bubble popped and took down the financial markets with it, newly appointed Fed Chairman Ben Bernanke came to the rescue with a massive bailout plan and a series of follow on quantitative easing programs. By printing $4 trillion dollars, the Fed managed to reflate housing prices and to erase all of the stock market losses incurred in 2008 and early 2009.

We may be nearing the end of the Fed’s ability to pick up the pieces after a crash. Before 1987 stocks did not always rebound so quickly and there have been generational losses in the stock market. It wasn’t until 1955 that the Dow returned to its 1929 peak. In 1966 the Dow was 1,000 and in 1974 it was 616. In the 70’s stocks fell for so many years to the point where a Business Week magazine cover proclaimed – The Death of Equities. The Dow did not return to its 1966 peak of 1000 until 1981.

Even though the Fed recently announced that they will begin to wind down the current round of QE, they have already printed $4 trillion and with the announced taper will still be buying $75 billion worth of U.S. Treasuries and mortgage backed securities a month. Thus, the Fed is still increasing the size of its balance sheet and continuing to provide support for low interest rates which is sustaining the stock and housing markets.

The Fed’s QE program has propped up the stock market and the real estate market for the past four years. The Fed may not be able to end QE or even taper it in a significant manner without causing interest rates to rise and the stock and real estate markets to correct or crash. We have noted over the past year that the Fed has a no exit dilemma. In the King is Surrounded we wrote: “The Fed knows that if they print too much they risk loss of confidence in the dollar and hyperinflation, and if they print too little, rates will rise and the economy will crash taking down the stock and real estate markets with it.”

With the appointment of Janet Yellen to the Fed chair position, now it’s the Queen who will find herself surrounded. The temptation for Ms. Yellen to continue the money printing may be too great for her to resist if interest rates continue their ascent and the job market does not show noticeable improvement.

The recent Fed decision to taper $10 billion a month from QE provides no meaningful clues as to the impact tapering QE might have on the stock market as the taper has not started yet and is small – just a $10 billion cut from $85 billion a month.

Given that the economy needs low interest rates, how will they be maintained if the Fed doesn’t continue to buy tens of billions a month of U.S. Treasuries and mortgage backed securities? Who will buy the bonds that the Fed doesn’t buy, and at what price? China, the largest foreign holder of U.S. Treasuries, has already signaled its intention to stop adding U.S. Treasuries to its reserves.

If the Fed continues to taper QE and higher interest rates ensue, causing the housing and stock markets to collapse, the “wealth effect” created by the Fed’s printing of $4 trillion will be gone. If higher rates cause a reduction in government spending there will be declining contributions to GDP.

What will the Fed do if faced with a stock market/economic collapse? Would the Fed reverse course and increase QE? Would it have any impact on interest rates?

Has the limit of Fed intervention been reached?

What will you do if the stock market crashes?

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If the stock market corrects more than 20% will you:

Humpty Dumpty Cartoon Credit: Can Stock Photos