Insights & Advice

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Don’t Fight the Fed

Now that QE II is in the bag, expect QE III, QE IV and maybe even a QE V, if that’s what it takes to restore economic growth and reduce the unemployment rate to under 7% in this country. After the mid-term elections results, I believe the Federal Reserve is all that stands between us and a stagnant, deflationary economy. I would not bet against them in this endeavor.

Most of Wall Street is expecting fiscal gridlock in Washington now that the GOP has re-taken the House but is still the minority in the Senate. That will mean little if any new initiatives to either grow the economy or drive down unemployment has much chance of passing. One exception may be a compromise on the Bush tax cuts.

If both sides can muster enough cooperation to cut a deal in extending the tax cuts before the end of the year (when they are set to expire) then we may escape an economic knock out punch of monumental proportions. Outside of that, there is not much that we should expect from the government over the next two years.

That means that only the Federal Reserve Bank, led by Chairman Ben Bernanke and his band of twelve governors, are left to wage the good fight against the forces arrayed against our economy. Their mandate, to promote low stable inflation and a high level of employment, gives them enough latitude to do just about whatever they feel necessary to jump start the economy. It appears they are doing just that.

QE II not only says the Fed is serious about that mission but signals an intention, in my opinion, that if this one doesn’t work, another one will already be in the pipeline, followed by another, and another. That is entirely believable since the Fed can and will continue to print money (U.S. dollars) until the cows come home in an effort to grow the economy, which is the only way they can reduce unemployment
In an Op-Ed piece in the Washington Post Thursday, Chairman Bernanke defended the Fed’s second quantitative easing and stated several things that you should read as Gospel:

“…the heavy costs of unemployment include intense strains on family finances, more foreclosures and loss of job skills”

“…inflation is running somewhat below 2%.”

“…higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

“…Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Bernanke said next to nothing about the dollar since he did not want to give the impression that the U.S. was deliberately driving the dollar lower (although that is exactly what QE II will do). . If you don’t believe that just take a peek at the decline in the greenback lately. As I have said in the past, the dollar will continue to weaken as the Fed prints more and more money. A lower dollar will boost commodity prices such as gold, silver, energy, materials and agricultural food stuffs. So ignore the naysayers who say commodity prices have run their course.

As far as the Fed is concerned, pumping more money into the economy is okay, at least for now, since the inflation rate is “a bit lower than the rate most Fed policymakers see as being consistent with healthy economic growth in the long run.”

But the most important message investors should take away from his Op-Ed is his extraordinary comment concerning higher stock prices. Evidently the Fed believes higher stock prices should be part and parcel of their attempt to grow the economy. Their reasoning makes sense when you consider that consumers are the lynchpin of this economy. Given that our two main pillars of wealth, our tax differed retirement savings and our homes, have taken a huge hit since 2008, any improvement in one or both of these assets should help improve our confidence and therefore our spending. That message is clear in the statements above.

The Fed is clearly telegraphing to investors that they want a higher stock market and like unemployment and the economy, they will do what it takes to accomplish that goal. This message is behind the jump in the stock market this week. My advice to you is don’t fight the Fed. Buy stocks.

Posted in A Few Dollars More, Portfolio Advice