Why Stocks in 2020 Could “Melt Up” Like 1999

By: TradeSmith Research Team

3 weeks ago | Educational

The dot-com boom, bubble, and bust of 20-plus years ago wasn’t just driven by tech stocks. It was also driven by monetary rocket fuel from the Federal Reserve — the world’s most powerful central bank.

Technology provided a great story, which served as the engine of the boom. But engines need fuel.

In 1998 and 1999, the Federal Reserve provided not just regular fuel to Wall Street, but rocket fuel in the form of interest rate cuts and liquidity injections. Without that turbo boost, the dot-com bubble never would’ve gotten as crazy as it did.

This matters because here and now, in 2020, the Federal Reserve could be doing a similar thing, for similar reasons, as in 1998 and 1999.

If similar actions provide similar results, another mania could be on the way — courtesy of Chairman Jay Powell and the Fed.

To pump up a really big asset bubble, and then turn euphoria into mania, you need a lot of really cheap money in the form of low interest rates and “liquidity injections,” operations where the central bank pumps cash into the market. That is the rocket fuel part.

The Federal Reserve doesn’t juice the market like that for no reason. There is typically some other event, like a crisis or a looming threat of crisis, that the Federal Reserve is responding to. The market mania then plays out as a kind of accidental side effect.

The Fed lowers interest rates or pumps liquidity into the market because of a big problem they are trying to solve or avoid. But once the liquidity is unleashed, the Fed can’t control where it goes, or how investors and speculators choose to respond. And that is why, sometimes, you get rocket fuel for a mania move.

When investors remember the dot-com bubble, circa 1995 to 2000, they tend to focus on the technology part. The Netscape IPO on Aug. 9, 1995, opened people’s eyes to the world wide web. The dot-com bubble that followed was fueled by euphoria, which then morphed into mania regarding the power of the internet.

That mania mentality, coupled with a belief that “profits don’t matter in the new paradigm,” drove internet stock valuations to stratospheric heights.

But in terms of what created the dot-com mania — what really drove stocks to otherworldly levels in 1999 and 2000 — a handful of events that had nothing to do with tech were just as important as the technology story itself. Those events included:

  • The Asian financial crisis of 1997
  • The Russian debt default of 1998
  • The 1998 meltdown of Long-Term Capital Management (LTCM), a giant hedge fund
  • The looming fear of the “Y2K bug”

Why did those events contribute to the dot-com bubble? Because the Federal Reserve responded to them all in crisis-fighting mode.

When the Federal Reserve pumped rocket fuel into the system in the late 1990s, it wasn’t doing it to make tech stocks go up. It was paying attention to crisis events in other areas of the market and other parts of the world. But once disaster was averted, tech stocks got the benefit.

In 2020, the same thing could be happening — and not just with the Fed this time, but with other central banks pitching in.

The coronavirus outbreak is a big and ugly event with serious ramifications for China, the global economy, and, by extension, the United States, too. If the world slips into recession, the U.S. will find it very hard to escape.

Because of this threat, the Federal Reserve might cut interest rates — not once, but twice — in 2020. That could make the market go crazy. Just the anticipated possibility is having an effect.

“Markets are putting pressure on the Federal Reserve for at least one rate cut,” reports CNBC.

“The fed funds futures market, where traders go to bet on the central bank’s policy direction, is pricing in about a 58% chance of a rate cut by June, according to the CME FedWatch Tool,” CNBC adds. “Traders are even making room for two cuts, assigning a nearly 60% chance of another move lower in December.”

In 1995, the Netflix IPO got the boom going. America Online (AOL), founded in 1985, was exploding in growth, and Amazon had just been founded in 1994. With these and other drivers, the mentality that formed the tech boom was underway. 

But then, in 1997, the Asian financial crisis led to the collapse of multiple Asian currencies.

And in 1998, a Russian debt default led to the collapse of LTCM, which was the most-leveraged hedge fund in the world at that time.

To deal with the fallout from Asia, Russia, and LTCM in quick succession, the Federal Reserve cut interest rates multiple times in 1998. Here is a CNNMoney excerpt from Oct. 15, 1998:

In the clearest sign yet that Alan Greenspan is concerned about an economic slowdown in the United States, the Federal Reserve Thursday cut short-term interest rates by a quarter point.
The move, the second time the Fed has cut rates in less than three weeks, shocked investors, sending U.S. stock and bond markets soaring…

The 1998 cuts followed a mini-market crash due to Russia’s default turmoil and the LTCM blow-up. Chairman Greenspan reversed the cuts in 1999, but by then, the “rocket fuel” effect had already sent tech stocks to the moon.

And then, adding fuel to the fire in 1999, Greenspan pumped the market full of liquidity yet again, because he was worried about the Y2K bug. 

“Greenspan Says Fear Could Be Worst Y2K Bug,” read a Los Angeles Times headline from September 1999. “Fed Stockpiles Cash for Y2K,” said a Wired headline from December 1999.

“Greenspan has engineered the biggest expansion of money supply in the Fed’s history in the weeks leading up to the end of the year,” Wired went on to explain, “when the so-called Y2K computer bug could disrupt financial systems.”

The Y2K bug wound up being a false alarm; or rather, legitimate concern over Y2K spurred corporate America to solve the problem in advance.

But “the biggest expansion of money supply in the Fed’s history,” which Greenspan had provided as insurance, wound up being more rocket fuel for tech stocks. That’s what enabled the mania.

This pattern of events from more than 20 years ago, which some would consider ancient history, matters today because we are seeing the Fed do a potentially similar thing.

The events of then and now — a mix of crisis and technology euphoria — also have a rhyming feel:

  • The coronavirus impact on the global economy is comparable to the Asian financial crisis.
  • China’s potential collapse is comparable to the disruptive impact of a Russian debt default.
  • The Federal Reserve under Jay Powell is prepared to “save the system” with cheap money.
  • The tech giants are making huge profits and inspiring disruptive business models.

And finally, signs of euphoria, if not full-on mania, are already here.

To give just one glaring example — though we’ve cited others in previous broadcasts — you can see this in the performance of Tesla stock, which is kind of the ultimate speculative bellwether for feelings of technology euphoria in the market.

As of this writing, Tesla shares have left the earth’s atmosphere like a SpaceX rocket. The sentiment around Tesla has gone from bullish to euphoric to manic to something else entirely — possibly added to by run-for-the-hills short-covering. Either way, the detachment from any sense of “normal” valuation in Tesla is enough to inspire awe. This is a notable mania barometer.

And so, it is possible — far from guaranteed, but possible — that the coronavirus outbreak and the possibility of global slowdown and China collapse could wind up helping the bull market transition into full-on mania stage in 2020.

If that sounds crazy, it shouldn’t at all, because that is more or less what happened 20-plus years ago, via the transmission method of the Federal Reserve.

The Fed, responding to danger in one corner of the market, accidentally poured rocket fuel into another. They could do a similar thing in 2020.  On a related note, Dr. Steve Sjuggerud over at Stansberry has put together a whole thesis around this idea — that the mania phase of the melt-up is only just beginning, and that 2020 could be the biggest year for stocks in decades. He’s got a big webinar on this topic planned for Feb. 12. You can find out more about the webinar and sign up here.

TradeSmith Research Team

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