cheerleadersWall Street has no lack of superstitions or old sayings. Traders try to read the rest of the year by January's performance, they worry about trading patterns like "Death Crosses" and they think it's smart to "sell in May and go away."

Despite the questionable track record of such "wisdom," investors would be wise to take one long-established truism seriously. The old admonition "don't fight the Fed" continues to stand, and Thursday's 220-point rally in the Dow Jones industrials following another round of quantitative easing by the Federal Reserve again demonstrates its merits.

Much of the speculation about the Fed's intentions tends to focus on its views of inflation as compared to unemployment, and understandably so. After all, the central bank's dual mandates are to ensure as much resource utilization as possible while maintaining price stability. And the Taylor Rule usually forms the backdrop of gaming most Fed thinking.

A Powerful Combo


But while the Fed tends to concentrate on these lofty macroeconomic relationships, some signs show that it's increasingly targeting a far more haphazard arena as well. The Federal Reserve seems to becoming increasingly aware of the big impact that rising "animal spirits" (in John Maynard Keynes's famous words) can have on the stock market and, in turn, the broader economy.

Investors should be aware that strong fundamentals like earnings combined with a Fed eager to boost stock prices could create a powerful combo. And that could lead to a boost in animal spirits.

In an op-ed for The Washington Post, for example, Fed Chairman Ben Bernanke ticks off the usual reasons for pushing down interest rates further: Lower rates on everything from mortgages to corporate loans should help the housing sector and boost business investment.

However, buried at the bottom of his list, the biggest self-perpetuating boom seems to come from rising stock prices. "And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending," Bernanke wrote. "Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion."

Boosting the Wealth Effect


Most people on Main Street see the stock market as a reflection of business conditions, but top policy officials like Bernanke are well aware of its ability to shape a self-fulfilling prophecy.

Indeed, prior Fed Chairman Alan Greenspan said so rather plainly in July, when the stock markets had seen a sharply rally during prior months, hiring was picking up steam and the country's economic spirits seemed to be on the mend: "While ordinarily we're seeing the stock market driven by economic events, I think it's more the reverse. What we do know is stock prices are a leading indicator."

The impact of the so-called wealth effect has fascinated Fed officials for some time. Central bank forecasters internally presented a newspaper clipping showing a boom in luxury boarding kennels more than a decade ago, for example, by including a photo of a dog with a caption that read: "I sure enjoy consuming master's recent stock-market gains!"

The view also touches on the long-held beliefs of some of the world's most successful speculators. Hedge fund legend George Soros has long pushed his theory of "reflexivity" as a counter to textbook economics. Soros contends that, unlike in the natural sciences, the social sciences consist of a feedback loop where participants' behavior is constantly modified by the outcomes they witness, and that in turn influences outcomes.

Like Greenspan before him, Bernanke also seems highly skilled at gaming market expectations. The $600 billion in new quantitative easing the Fed announced gave a frenetic market just what it wanted. At the same time, the door remains open for further easing should things slow.

In the long list of high-minded concerns that come out of Federal Reserve meetings, stocks are hardly ever mentioned -- let alone animal spirits. Yet investors should note that the august body knows well that boosting stocks can give the whole economy a big push.

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marcus.hussy

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April 13 2013 at 7:49 AM Report abuse rate up rate down Reply
otterdad48

Funny how some folks see that bailing out failed capitalists as good but investing in the ecnomy as evil socialism. Go figure.

November 06 2010 at 2:24 PM Report abuse rate up rate down Reply
Robert & Lisa

The demoncrats take more and more from we the people, not realizing they, like parasites will eventually kill the host animal (our country) and as a result themselves. Stupidity reigns supreme.

November 06 2010 at 4:30 AM Report abuse rate up rate down Reply
hjgjghkh

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November 05 2010 at 11:19 PM Report abuse -1 rate up rate down Reply
pmurph2000

Enough of this COUNTERfed money. End the Fed, put Bernanke and Greenspan in jail.

November 05 2010 at 7:50 PM Report abuse +2 rate up rate down Reply
1 reply to pmurph2000's comment
Robert & Lisa

Don't forget Obama and thugs, to jail.

November 06 2010 at 4:31 AM Report abuse +1 rate up rate down Reply
fasteddie1257

Nice pic...Roll Tide. Stop the presses long enough for America to recover. Cut taxes instesd.

November 05 2010 at 5:55 PM Report abuse +1 rate up rate down Reply
MSmailbox

In terms of "algebraic spirits," what does it matter whether I have $1 or $10, or even $100, if they all buy the same loaf of bread? Perhaps, I'm missing something... Ah yes, "animal spirits." This is your economy, this is your economy on drugs! When we awaken, we'll all be in the same position, just a little more bleary-eyed and missing our wallets.

November 05 2010 at 3:04 PM Report abuse +1 rate up rate down Reply
bigtruckerman

The QE's is no different then what Germany did in the 1930's. There were people carrying suitcases full of money just to buy a gallon of milk. The German goverment was making money just like we are right now. This in turn lowers our dollar to foreign currencies. For example the price of oil is going up due to the fact it takes more dollars to buy foreign oil. The dollar could become worthless if the goverment keeps making more money. This is a dangerous period of time to be in the stock market, the goverment is trying to boost everyone's spirit up to make it look good but where is the foundation to hold it up? The manufactoring jobs for the lower skilled workers are gone all 40400 companies, not jobs but companies. If the congressmens do not do anything about this then don't wait for the next election recall them immediately!!! All of them......

November 05 2010 at 11:24 AM Report abuse +7 rate up rate down Reply
2 replies to bigtruckerman's comment
scottee

so this is what we want? is this okay with everyone? why can't we audit and end The Fed? why can't we cut congress' salary and benefits? and why can't we get the current tax code replaced by a fair tax? just wondering?

November 05 2010 at 11:26 AM Report abuse +4 rate up rate down Reply
bigtruckerman

You can reply to me at Bigtruckerman@aol.com

November 05 2010 at 11:44 AM Report abuse rate up rate down Reply
scottee

The Fed needs to be audited and ended but first it needs to put the dollar back on the gold standard...please!

November 05 2010 at 11:22 AM Report abuse +6 rate up rate down Reply
1 reply to scottee's comment
bigtruckerman

The only way we can control congress is to get 38 of the states to ratify the US Constituion to have congress follow the same laws that they pass onto us. Or the states could refuse to enforce the laws that congress impose on them if the Federal does not give 100% of the funding and prove to the people that it was given to that state. This would put an immediate stop to the frivoluos laws that congress passes. If congress refuses to give the states their money due then it becomes taxation without representation.

November 05 2010 at 11:33 AM Report abuse +3 rate up rate down Reply
butteparts1

Edit error-" buckets full"

November 05 2010 at 9:31 AM Report abuse rate up rate down Reply