Do Fed Policies Fuel Bubbles? Some See GameStop as a Red Flag

“When essentially your central bank has drawn a line in the sand, as they did last March, then people understand that it’s a one-way bet,” said Paul McCulley, former chief economist of Pimco, a giant asset management shop.

The SP 500 stock index has jumped more than 70 percent since then. To put the breakneck speed of that run-up into context, the SP 500 has climbed about as much over the past 10 months than it had in the four years leading up to the pandemic.

When it comes to the Fed’s influence on stock prices, some of it is purely mechanical. When companies can borrow for less, it allows for bigger profits and cheaper business expansion opportunities, which could elevate their worth in the eyes of stockholders. Some of the increase probably reflects the reality that super-low rates push investors out of bonds and into riskier assets like stocks as they seek better returns.

But analysts warn that part of the run-up simply owes to sentiment: Investors believe stocks will go up, in some cases because they believe in the Fed, and so they keep buying.

The downside is that people can lose faith in an ever-rising stock market. And when the music stops, an optimism-fueled bubble can become a pessimism-pricked burst.

GameStop in particular “does illustrate some of the financial vulnerabilities that can stem from ultra-loose monetary and fiscal policies,” Neil Shearing at Capital Economics wrote in a research note last week, noting that super-low interest rates, government stimulus payments, lockdowns and platforms that democratize trading have all come against a backdrop of “longstanding societal strains and the perception of a widening schism between Wall Street and Main Street.”

Still, Mr. Shearing said in an interview, the stock market as a whole does not yet look dramatically overextended, and the Fed needs to focus on righting a pandemic-damaged economy — which is the goal of its low-rate and bond buying policies.

Article source: https://www.nytimes.com/2021/02/09/business/economy/gamestop-fed-us-economy-markets.html