Investing in today’s stock market doesn’t come without risk, especially during volatile times. Understanding stock market fundamentals is of great importance.
Opportunistic brokers and so-called investment experts are misleading the novice and even at times the experienced investor, and some are misusing clients’ funds. One needs only remember the Ponzi schemes perpetrated on even the most knowledgeable investor during the past years.
Now, one hears voices from the established investment community, not just from individual investors, stating that the stock market is manipulated.
“‘The markets are rigged’ is a complaint that is being increasingly heard across the investment landscape. … This is actually a critically important issue that warrants much deeper examination,” a March 22 article on the Seeking Alpha website suggests.
One argument discussed in the investment community is that the U.S. Federal Reserve System (Fed), with its quantitative easing (QE) policy, is manipulating the stock market.
QE is a policy used by the world’s central banks to increase the money supply. For example, the U.S. central bank buys securities, mainly U.S. Treasury notes and mortgage-backed securities in the market, providing lending institutions with increased liquidity. This method is used to stimulate the economy.
Discussing the Fed’s QE policy, a Feb. 24 Zero Hedge article suggests, “We [the U.S.] are persistently manipulating quite a few major asset markets here. Against this backdrop, market participants are not able to price risk properly. We are encouraging financial risk taking.”
On March 14, 2012, Charles Biderman, CEO of TrimTabs Investment Research, discussed QE on his TrimTabs Money blog. “The Fed continues to rig the market. As long as the rigging continues and investors keep believing in the tooth fairy, stock prices will hold up.”
Digging Deeper for Answers
“In critically evaluating this question as to whether markets are rigged, it is worthwhile to go through a logical progression to consider the information available to support this point,” the Seeking Alpha article suggests.
Four questions should be asked—who, what, why, and how—before deciding if the market is rigged and by whom.
The first step is to find the entity with the power to manipulate the markets. It is said that the United States functions in a so-called free market system. This is a misnomer, as the government regulates the market to stop market participants from defrauding or influencing the markets and has the ability to enforce its regulations.
“Thus, it is the government in the end that has the ability to rig the markets,” the Seeking Alpha article states.
Then there are large companies, such as Goldman Sachs Group Inc. and JPMorgan Chase & Co., that make a significantly higher profit than others, but do not violate existing regulations. Therefore, one can’t accuse them of rigging the market.
“But if government regulators become knowingly involved in providing an unfair advantage [to] those on one side of a trade over the other, then we have a rigged market,” the Seeking Alpha article suggests.
Next, realizing that the government has the ability to rig the market, one has to narrow it down to what agency has the power and resources to not only perpetrate such a scheme, but to keep it secret.
That eliminates legislators. “Given that they can’t seem to agree on anything nowadays, it’s unlikely they are operating a finely tuned market manipulation scheme behind the scenes,” the Seeking Alpha article states.
Narrowing it down much further, the only entity with the power, resources, and knowledge would be the Fed, given that the members of the Board of Governors are appointed for 14-year terms, and the chairman is appointed for four years but not restricted by any term limits. Also, the Fed is responsible for printing and controlling the U.S. currency.
“If anyone is rigging financial markets, the only clear candidate is the U.S. Federal Reserve,” the Seeking Alpha article suggests.
The follow-on question would then be to ask why the Fed would rig the market. It is known that among other reasons, the Fed wants to see a well-functioning stock market and keeps interest rates low so mortgage loans would be more affordable. None of what is known about the Fed points toward rigging the market.
Lastly, the question of how takes a closer look at the Fed’s monetary and QE policies, which are meant to stimulate the markets. Without doubt, the course taken by the Fed has influenced the markets and stock in an upward trend.
“The Fed has explicitly stated its objectives and has implemented programs designed to achieve these objectives. … The Fed has done nothing more than accomplished what it explicitly stated it was setting out to do with its policies,” according to the Seeking Alpha article.
In conclusion, the Seeking Alpha article states that there is nothing that shows the market is being manipulated and not one shred of evidence available that would point to the Fed as the culprit of rigging the market.
“The markets are not rigged, but this does not mean that they are not absolutely unpredictable and maddening for extended periods of time. But opportunities still exist in these markets, no matter how far under the influence they may be,” the Seeking Alpha article concludes.
Opposite Point of View
Biderman states on his Jan. 30 TrimTabs Money blog that he is clear on how the Fed rigs the stock markets.
“Here is what happens, as I see it now. Every day, Federal Reserve traders are buying about $4 billion in long term treasuries and mortgage bonds from major trading houses,” Biderman said in his article.
The Fed doesn’t pay cash, but credits the trader’s account, which can be left in the account or withdrawn in the form of cash.
“To make this really simple, the Fed creates $4 billion a day and eventually some of that money goes into equities. And that, of course, helps keep stock prices elevated. So it doesn’t matter that we are having major problems with the underlying economy and markets that normally would depress stock prices,” Biderman explains.
The major banks keep all their funds on deposit with the Fed, which are actually credits on the book, but are not backed with real money.
“Why is the Fed doing something that would be a crime if anyone other than the Fed did this? That’s because wealth creation is the only policy action of this government that works,” according to Biderman.
Cost of QE Unknown
“The Federal Reserve Chairman has consistently stated that the cost of the quantitative easing program is unknown. Essentially, he’s saying that excessive money printing can create a high inflation environment, but he doesn’t want to admit it,” according to a March 21 article on the Seeking Alpha website.
Continuous printing of money could result in high inflation. During high inflation, stocks could underperform instead of outperform. Investors are willing to take only so much risk, expecting a specific return on their investment, and are showing signs of the jitters when discussing the Fed’s QE policy.
“Chairman Bernanke has a tiny needle to thread—he must convince investors that quantitative easing will create just enough inflation to make multiples expand while also guarding against the inflationary consequences of hyper-expansionary monetary policy. The margin for error is slim,” the Seeking Alpha article states.