I hate daylight savings time and I hate liquidity crises. Daylight savings time wreaks havoc on my biological clock and it makes it nearly impossible to get my daily groove going. Liquidity crises are bad news for my portfolio.

To compound the problem, especially during periods when they occur simultaneously, I tend to drink too much caffeine at the wrong time during the day and then have trouble sleeping at night. All of which makes everything even worse.

I’m not alone. There are plenty of studies available that confirm the negative effects of daylight savings among large numbers of people. An interesting take on this subject was penned by Antonio Siganos, a senior lecturer at the University of Glasgow. Here are some highlights:

• Mental health is negatively affected by the time change;
• Automobile accidents increase during daylight savings time; and
• There is an increase in cardiac problems as a result of the time change.

What’s more interesting is that Siganos concludes that the financial markets are negatively affected by the time change as well. I resemble that remark.

Certainly, his focus is based on data related to investors in mergers and acquisitions (M&As). But it doesn’t take a whole lot of imagination to consider that if M&A investors are affected, then so is everyone else in finance such as day traders, portfolio managers, retail investors, and yes…central bankers.

All of which brings me to the timing of the unfolding banking crisis and the response from regulators, e.g. the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve. While the FDIC is in some ways trying to mitigate the problems, the Fed is not being very helpful, especially when you consider that the liquidity crisis which has led to the banking disaster is a direct result of central bank policy over the last 15 years.

Yes, the Fed has created new facilities to allow banks to borrow money at low rates, while setting up swap lines of credit with other central banks. This will offer billions of liquidity to the banking system.

But it’s not the big gun the stock market needs, which is lower interest rates and qualitative easing (QE).

In response to the COVID pandemic, the Fed lowered interest rates too far and held them too low for too long. When inflation surged, they waited too long to raise rates, and had to raise them too aggressively. The result has been a full blown liquidity crisis. In other words, the Fed took out too much money from the banking system too rapidly. The net effect was to force poorly capitalized banks to sell Treasury bonds at a loss, which in turn pushed many of them into insolvency.

Financial Markets are in Wait and See Mode

I certainly am not one to look a gift horse in the mouth. So, when the Fed eases interest rate policy, I get excited. That’s because stock prices tend to eventually rise in response. But as I noted in my recent article, it can take quite a while for rate cuts to induce bull markets. For example, after the 2008 subprime crisis it took the Fed ten rate cuts over a year to finally jump start the next bull market.

In today’s market, however, the robot traders (algos) are likely to move stock prices quickly. That means that bad news from the Fed will likely lead to aggressive selling, while good news will likely lead to equally aggressive buying.

Here is where things stood just prior to the Fed’s announcement on its interest rate plans on 3/22/23. Expectations were for a quarter point increase in the Fed Funds rate and perhaps some sort of hint that there would be a pause in raising rates due to the banking crisis.

The S&P 500 (SPX) was trading above 4000 and its 200-day moving average. The Accumulation Distribution Indicator (ADI) was ticking up as short sellers moved out of positions in expectations (more likely hopes) that the Fed would do the right thing.

The market’s breadth as measured by the New York Stock Exchange Advance Decline line (NYAD) was trading with little conviction near its 200-day moving average. The Eurodollar Index (XED), a reliable measure of the market’s liquidity, bumped up against the 95 area but rolled over. The CBOE Volatility Index (VIX) was also heading lower.

For its part, the bond market seems to be stuck in neutral, divided between the notion that lower rates from the Fed could be inflationary. That’s why the U.S. Ten Year Note yield (TNX) has rebounded after briefly breaking below 3.5%.

The bottom line is that most indicators suggest the market is waiting for the Fed to make its move.

It’s not what you can do for the market. It’s what the market can do for you.

The Fed is living in the past as it views the relationship between the economy and the financial markets in terms of the economy being the primary influence. The Fed and traditional economists see the economy as the driver for the direction of stock prices. As a result, monetary policy focuses on the economy, which is why the Fed has continued to raise interest rates not just based on inflation measures such as the consumer price index (CPI), but also on the so called “strong” labor market.

The reality on the ground is totally different now. Ironically, this is partially due to a combination of Fed policy as well as fiscal policy from the government which has encouraged businesses to expand globally.

The net result is that where once people’s jobs were their primary sources of income and wealth building (the economy), in the present, it’s the stock market and investments in general that are the primary wealth building tools.

This can be best envisioned through what I call the MELA System (M is for Markets, E-economy, L-life decisions, and A-algos). I describe MELA in detail here.

The short version is that when stock prices rise, so do the values of 401k plans, Individual Retirement Accounts (IRAs), trading accounts, and even whatever is left of crypto accounts. The value of these accounts creates a “wealth effect,” which nets the following:

• Investors feel wealthier when their trading accounts rise (markets) and are willing to make large purchases (life decisions); and
• Bankers who review the client’s accounts are more likely to lend money to those whose 401k is doing well.

Therefore, rising stocks induce a virtuous cycle which leads to a vibrant economy. Of course, the opposite is true as we’ve witnessed over the last few months as the Federal Reserve has raised interest rates.

At the same time, artificial intelligence (algos) has created an environment in which program trading of stocks is now responsible for as much as 80% of the trading volume on Wall Street. This has expanded into the options market, which now has become an influence of stock prices instead of a reflection due to the link between the trading machines and hedging strategies.

Moreover, the 24-hour news cycle, the rapid spread of news, and the attachment of most people to their cell phones leads to rapid responses to news events which accentuate any dynamic around the world, but especially the financial markets.

Bad Combo

The Fed is looking at the relationship between the economy and the financial markets based on a 1970s viewpoint.

The world has moved on. It’s the stock market that drives the economy now. So, whether the Fed likes it or not, or whether they admit it publicly, the financial markets will continue to exert their influence on the economy, based on what the Fed does.

Making matters worse, businesses have increased their reliance on debt over the past decades. This reliance on debt has been financed by record low interest rates. When the Fed raised rates aggressively, highly indebted companies and consumers began to feel the pinch of restrained liquidity.

Thus, badly managed banks have been the first to fall. If the Fed continues to raise rates, more banks will fail and companies in other sectors that are highly indebted will follow as their debt-based financing will dry up. As stock prices fall, the value of investments will also fall and the negative effects of the Fed’s higher rates will spread.

That means that until the Fed lowers rates and perhaps accompanies the move with at least a modest amount of QE (money printing), regardless of the inflationary effects, we will continue with high levels of volatility and a generally bearish trend in the markets and the economy.

What’s the take home message? Lower rates will eventually improve the action in the stock market and 401k plans and other investment accounts. If recent history is any guide, the economy will likely follow.

Let’s just hope that the Fed isn’t prone to feel the effects of daylight savings time.

Editor’s Note: Looking for an investment advisory that generates results, despite the risks described above? Consider our premium trading service, Rapier’s Income Accelerator, helmed by my colleague Robert Rapier.

Robert is our in-house income expert. He can show you how to reap exponentially more income out of dividend stocks, by using his simple time-proven method.

Robert Rapier’s system works, regardless of economic ups and downs or stock market gyrations. Click here for details.