Is there a catalyst?
Whenever the stock market hits new highs, traders start buzzing about a new market crash. And so it is with the Dow Jones Industrial Average ($INDU) and the Standard & Poor's 500 Index ($INX), which hit new highs at the end of March and have continued to move higher since.
But is the market poised to crash?
While there's no denying that the dramatic rebound from the market lows of March 2009 suggests a correction at some point, to get a real crash -- say, 30% or more from the recent highs -- would require a real and specific catalyst.
A catalyst can be something like the collapse of Lehman Brothers in September 2008, or simply a stock run-up so fast and so far, like the Nasdaq ($COMPX) rally in 1999 and 2000, that the market falls apart just because.
It can also come entirely out of left field, like the Arab oil embargo of 1973-1974. Or the Russian debt crisis of 1998 that trimmed the S&P 500 by 12% in roughly three weeks.
The point is that the catalyst has to be sharp and real.
· The Federal Reserve reverses course without warning
· Odds of happening: Low
· Since the 2008 market crash, the Federal Reserve Board under Chairman Ben Bernanke has engaged in a previously uncharted course of keeping interest rates at ultralow levels via massive purchases of Treasury and mortgage securities until a real recovery has proved it's self-sustaining. The result is that the interest rate on a 30-year mortgage is under 3.7%. A 48-month loan on a new car is around 2.6%.
· The policy has legions upon legions of critics who denounce the Fed as setting the stage for a property bubble, like the housing bubble that began to burst in the late summer of 2005. In fact, they say the Fed was largely responsible for that bubble.
· An abrupt turn in policy would shock everyone, because the Fed has been so clear that it wants to see the nation's unemployment rate fall substantially (to 6.5%, maybe lower) before it even thinks about a change.
· An unexpected policy change would almost certainly push interest rates immediately higher and slam stock prices. (Stock prices generally move in the opposite direction of interest rates.) Most important, a sudden and sharp change in Fed policy would derail the recovery.
· There's history of markets reacting badly to a sudden tightening. On a Saturday night in October 1979, the Fed under then-Chairman Paul Volcker announced it would sharply raise interest rates to curb inflation; the S&P 500 fell more than 10% in the next three weeks.
· The Fed under Bernanke doesn't like to surprise markets. So, its minutes and speeches by Fed officials are analyzed for signs of policy shifts. And it looks as if the Fed is discussing a possible scaling back of its bond purchases, now at a maximum of $85 billion a month, to answer the critics. An answer may come in August when the Fed holds its annual get-together at Jackson Hole, Wyo. It could signal the start of a gradual policy change.
· This is not to say the Fed's policy since the fall of 2008 has been correct. But the Fed has a dual mandate: to keep inflation low and to promote full employment. So it has felt compelled to act to boost the economy, in large part because Congress has not.