Why The Correction Is Not Done!

From the Christmas rally in 2021, we have seen $S&P 500(.SPX)$ hit an All Time High of 4818.62, $NASDAQ(.IXIC)$ hit 16,212 in Nov. For the ease of discussion I will only refer to NASDAQ and SPX as the indicators of the US Equity Market. 

The recent inflation data, CPI of 7.5% YoY growth goes to show that the Federal Reserve has done a poor job in maintaining price stability.  The excessive Quantitative Easing which started in March 2020 has flooded the economy with so much liquidity that the prices of assets to skyrocket (not to mention virtual money, JPEGs and even real estate). All this can only occur in a extremely accommodative environment with zero interest rates. 

And now, with CPI seeing a 40 year high, the Federal Reserve is clearly behind the curve. They'll need to conduct a much more aggressive rate hike policy as well as balance sheet reduction. Mind you rate hikes will only take affect on the equity market after about 6 months.. 

What is scary about the situation we're in right now is the call for a much more aggresive monetary policy tightening as well as the rapid reduction of balance sheet. 

The Federal Reserves generally has 3 steps to end a Quantitative Easing. 

Step 1: Tapering - reduction of asset purchase. Still pumping money into the economy but at a reduced rate. 

Step 2: Rate hikes - increasing interest rates occur generally after the tapering has been concluded. Increasing interest rates will lower demand side of the economy, thereby bringing down the inflation level. 

Step 3: Balance sheet reduction - this is the most destructive to equity valuation because you're removing the money in the economy. The Fed will either let their securities mature or by selling securities. Less money out there, lower valuation, simple. 

The last time this happened was with tapering beginning in 2017 Oct, the whole thing took about 46 months but the Fed ended up reversing course and had another round of QE in 2019.

This time we only took 4.6 months from Tapering to QE and possible Balance Sheet Reduction by June (or much earlier, we will probably get an update from the Fed's Emergency Meeting on the 14th Feb). 

I don't know about you but I think the dip is just a falling knife. 

Anyway have a great weekend! 

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