Fed Herding Investors to the Slaughter?

Why do the markets enjoy the hardship of others?

 

Specifically, why does news that last month 190,000 jobs disappeared in
the U.S. and another 43,200 vanished in Canada spur stocks? North
American markets rose in early trading before going almost flat before
noon. So how sadistic are these capitalists?

Well, for one good explanation it’s worth turning to the Pragmatic Capitalist,
a much-loved blog on the markets. PC argues that the U.S. Federal
Reserve’s policy of anemic interest rates is forcing investors to incur
greater risk because traditional safe havens like insured bank accounts
and government bonds don’t offer any return to speak of. Fed chairman
Ben Bernanke is essentially pushing investors into the stock markets to
find any sort of returns. As the markets keep rising, investors are
buying into “Bubbly

 

Ben’s” idea that a country can print its way to
prosperity.

 

“The real question investors need to ask
themselves is this: if we truly are in the middle of a Fed-induced
liquidity rally where the fundamentals simply don’t matter, do you buy
now or wait it out for the inevitable bust?”

There are plenty of perma-bears who share this view. Chief among them is Bob Prechter who says that stocks and commodities are topping and the US dollar is set to rally:

“I
think stocks are topping out, commodities are topping out and the
dollar is making a bottom,” says Robert Prechter, president of Elliott
Wave International and author of “Conquer the Crash“.

 

According to Yahoo Finance – Tech Ticker, Prechter also makes the seemingly counterintuitive argument that the dollar will rally because
there’s so much debt, rather than being doomed because of it. “If the
economy turns sour again in 2010, as he predicts, Prechter says the
dollar will benefit as more dollar-denominated IOUs get called by
creditors seeking to shore up their own balance sheets, as was the case
in 2008.

 

“A sustained rally in the dollar would
have devastating consequences for stocks, emerging-market assets,
high-yield debt and commodities. But gold might be the exception,
because it represents ‘real money’ and more people are questioning the
global paper money system, Prechter says.”

It might be a good time for all of you to review the three triggers of the global gold bubble and read the views of Dr. Doom vs. the Investment Biker on asset bubbles summed in the Globe and Mail by Simon Avery:

My
views have not changed in the last six months. We got a coordinated, unprecedented liquidity injection in the global financial system and severe performance anxiety propelling risks assets higher.

The
key question now is how long can this last? If history of the markets
has taught us anything, the answer is a lot longer than what most
investors think.

The biggest problem is trying to
figure out liquidity. The linkages in the global financial system are a
lot stronger in 2009 than they were in 1920. Moreover, with the advent
of shadow banking and sovereign wealth funds, the financial system
plays a dominant role in the real economy. Unlike past crises, the
synchronized global downturn happened when banks stopped lending and
global trade came to a grinding halt.

Then, as
central bankers pumped trillions into the global financial system,
banks made a killing off trading profits. And now, the message from the
Fed is clear, let the bubble blow. The Fed is telling the banks to go ahead and bid up risk assets because we need to combat the perceived threat of deflation.

Of
course, it would be highly irresponsible of the Fed or any central
banker to come out and say they want inflation, but that is what they
and the world’s power elite want. The interesting thing is how they’re
going about it. The Fed is giving the banks the green light to go ahead
and trade away, bid up risk assets and hopefully an asset bubble will
lead to real economic inflation.

So, we can expect more bubble trouble as another bubble forms sooner than we think.
Will this end badly, slaughtering investors down the road? Not
necessarily. Think about Schumpeter’s creative destruction and read
Mort Zuckerman’s recent op-ed in the Financial Times which argues that
the free market not up for the job of creating work.

Its
not all gloom and doom. I see a positive secular story developing in
renewable energy, emerging markets, healthcare, infrastructure,
nanotechnology and other technologies. But there is no doubt that the
sea change will be disruptive to hundreds of millions who will face
hard times before we restore sustained confidence and integrity in our
global economy and financial system.