Thursday, July 18, 2013

John Mauldin's Outside the Box: The Mirror Cracks

This reminds me of something else I was thinking about this morning. I was trying to think about a good analogy to the way the markets currently seem so dependent on Fed action/intervention. The thing that came to mind was Taleb’s turkey problem….for 1,000 days a turkey gets fed by a butcher. Every day that goes by the turkey gets more and more confident that this butcher is nice and is looking out for its well being. Until day 1,001 (a few days before Thanksgiving) when the butcher kills the turkey. The turkey was most confident in the thought that the butcher would always feed it and do good for it at the point just before the butcher delivered the Black Swan to the turkey (Black Swan for the turkey, not a Black Swan for the butcher). The markets seem to be acting similar to the turkey in response to the Fed, its equivalent of the butcher. The lesson: Don’t be a turkey.

The comparison between the recent interest rate spike and 1994 underlines just how Fed-dependent markets have become and how incredibly difficult it is going to be for Mr. Bernanke and his colleagues to alter policy without causing serious market dislocations…. 
Mr. Bernanke is creating the conditions for a violent market reversal. As I wrote last month (“Delusions of Stability”), the dependence of markets on the continued beneficence of the Federal Reserve is profoundly unhealthy.