The Real Secret of Fed Printing and Bull Market

A very large amount of retirement money is parked in target date retirement funds. Someone can buy one of these funds when they are younger with a target date equal to their planned retirement age. The fund will have a large allocation to stocks and a small allocation to bonds.

The buyer may make regular additional purchases of the fund. Every few years, the fund will increase its bond allocation and decrease its stock allocation until the target date, when it will have a large allocation to bonds and a small allocation to stocks.

Imagine a large fund that is supposed to maintain a strict 50:50 stock:bond allocation for this calendar year. When the Fed buys bonds to provide liquidity and suppress interest rates, the market value of bonds goes up. If you manage a 50:50 fund and the value of the bonds goes up, you are forced to sell some of the bonds and buy stocks to maintain the balance.

And therein lies a critical transmission mechanism. The Fed buys $120 billion of bonds every month. The rules-based funds sell bonds to buy stocks. Stocks go up. Rinse and repeat.