Too fast, too furious. That describes the April/May advance following the fastest 30% decline in history. The reason was not an improvement in fundamentals, but a generation of investors front running Fed liquidity flows. Such should not be surprising as this is what was intended by the Federal Reserve from the outset. The Fed delved into “classical conditioning” to specifically obtain the outcome they wanted. Classical conditioning (also known as Pavlovian or respondent conditioning) refers to the learning procedure where a potent stimulus (e.g., food) is paired with a previously neutral stimulus (e.g. a bell). Pavlov discovered that when introducing a neutral stimulus, the dogs would begin to salivate in anticipation of the potent stimulus, even though it was not currently present. This learning process results from the psychological “pairing” of the stimuli. As noted in yesterday’s post, in 2010, then-Fed Chairman Ben Bernanke introduced the “neutral stimulus.” By adding a “third mandate” to the Fed’s responsibilities, the creation of the “wealth effect,” the neutral stimulus was achieved. Importantly, for conditioning to work, the “neutral stimulus,” when introduced, must be followed by the “potent stimulus,” to complete the “pairing.” For investors, the introduction of each round of “Quantitative Easing,“ the “neutral stimulus,” the rise of the stock market was the “potent stimulus.” Given the massive interventions into markets by the Federal Reserve, as Bernanke noted, “investors anticipated the additional action” and jumped back into the stock market. The Fed was successful in fostering a massive lift to equity prices and a corresponding lift in consumers’ confidence. Unfortunately, there was relatively little translation into wages, full-time employment, or corporate profits after tax, which ultimately triggered very little economic growth.