The Federal Reserve Has Worked it Out, Good News for Stocks

You probably know about Classical Conditioning.

Even if you don’t know the term, you probably know the most famous example of it — Pavlov’s dog.

Do you know it?

We’re sure you do. And as an investor, you should be well aware of how it has impacted investors for the past six years.

Except it seems those running the experiment in classical conditioning didn’t realise the impact, until now. Now they understand it. What impact will this cruel experiment have on the markets?

Let’s find out…

Before we explain the experiment and what it could mean for investors, we’ll explain the Pavlov’s dog scenario.

It was an experiment by Ivan Pavlov. When he gave his dog the smell and taste of meat, naturally the dog salivated. At the same time as doing this, he also rang a bell.

He repeated this several times to ‘condition’ the dog. Eventually, Pavlov removed the meat entirely from the experiment and just rang the bell. Due to the conditioning, the dog salivated. It had associated the ring of the bell with the taste and smell of the meat to produce the same reaction as before.

See, it’s simple. Interestingly, Pavlov wasn’t the only chap to study conditioning. Edwin B Twitmyer at the University of Pennsylvania, and John B Watson at Johns Hopkins University here in Baltimore, were studying similar topics around that time.

It’s a fascinating topic, especially from an investment angle, as it’s something investors have dealt with over the past six years.

Pavlov’s Fed

We bring this up due to a story from Bloomberg today:

‘Some Federal Reserve policy makers were concerned investors may be growing too complacent about the economic outlook and the central bank should be on the lookout for excessive risk-taking, minutes of their June meeting show.

‘“Signs of increased risk-taking were viewed by some participants as an indication that market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy,” the minutes showed.’

Well, they don’t say. You don’t need be a qualified CFA to know that if the central bank prints billions of fresh money to prop up the market when things look dire, that investors will soon expect that to happen every time.

Looming crisis? Don’t worry, the central bank will crank up the printing press.

Company earnings falling? Don’t worry, they’ve got the printing press remember?

Consumer confidence falling and unemployment rising? Easy, they’ll just print more dollars.

So how can anyone in their right mind not see that this behaviour would condition investors to expect more of the same with each new problem?

Yet it seems some of the folks at the Federal Reserve haven’t figured it out. But we guess it confirms one thing: that no one of a sane mind works at a central bank.

A crash is too obvious

So, that’s all fine. You know what’s happened. And now the Fed knows what’s happened (belatedly).

What does it mean?

It can only mean one of two things.

The knee-jerk reaction from those who have predicted a crash almost every day since stocks bottomed in 2009, is that this is the ‘ring the bell’ at the top of the market moment.

They’ll say now that the Fed realises that investors are complacent, the Fed will do something to get rid of the complacency. They’ll talk the market down by talking about asset bubbles, or they’ll just let the market crash.

Do you think that seems likely? After the Fed has spent the past six years doing everything necessary to talk stocks up and prevent a crash, will they decide they’ve gotten things wrong?

We’ll be straight. We just don’t see it.

In fact, our bet is the exact opposite will happen.

Read the rest of this article at Money Morning