The Independent Investor: Will the Fed Falter?

As we enter the fifth year of the Federal Reserve Bank's grand experiment to save our economy, doubts are beginning to surface. After a wonderful run in the financial markets, investors are concerned that the Fed is planning to once again slow their stimulus program. That would be a mistake.

 

To understand why, just recall the ups and downs of the economy and stock market over these same five years. The first attempt at jump-starting the economy by the Fed occurred in late November 2008. The Fed started buying $600 billion in mortgage backed securities in an effort to inject liquidity into financial markets frozen with fear. It worked. By March 2009, it held $1.75 trillion of bank debt, mortgage backed securities, and Treasury notes, and reached a peak of $2.1 trillion in June 2010.

 

As the stock market and economy started to improve, the Fed thought its job was done and discontinued further purchases. In hindsight (which is always 20/20) that was a mistake. The economy and markets proved to be too fragile to continue to climb on their own.

 

In November, 2010, the Fed had to announce a second round of easing (QE II). Both the economy and markets, which had been slowing rapidly, once again responded positively to the new program. You would think the Fed would have learned their lesson and continued QE II until they were sure that the economy could grow on its own, but that didn't happen.

 

As QE II was winding down so did the economy and stock markets again. The Fed's action, although well-intentioned, was creating what I called a "stop and start economy." As a side effect it was also creating enormous volatility in the financial markets.

 

Finally, in September 2012, it appeared the Fed had learned its lesson. They announced another QE, but this time promised that the stimulus effort would be open-ended until the economy and employment was on firm footing. They committed to purchasing $85 billion in U.S. Treasuries and mortgage backed securities per month, while keeping the Fed funds rate near zero to at least 2015.

 

In the absence of any help from the fiscal side of the government, investors and corporations are now conditioned to rely on the Fed. No one thinks that is a good thing but until the economy can grow on its own, the Fed's actions are the only game in town. So bolstered by this new QE Infinity approach, the private sector began to invest. Unemployment drifted lower and despite the government's best efforts to drive us back into recession (the Sequestration), the economy was actually building up some steam.

 

Stock markets roared to life and never looked back. So if all of this sounds like a real success story, what's the rub? On May 22, within the minutes of the Federal Open Market Committee Meeting, investors discovered that some board members were discussing the end to QE Infinity as early as this month.

 

Since then the stock markets has been drifting lower and, although it is early, I suspect that once again corporate board rooms across the country are re-examining plans for future expansion. Now why would the Fed, thrice burned by their own actions, once again want to discontinue their stimulus program, despite the fact that neither the economy nor employment is anywhere near their growth targets?

 

Are they afraid of some kind of stock market bubble? Some board members have complained that QE Infinity has taken uncertainty out of the stock market and investing. They worry that investors are taking more and more risks because they know the Fed has got their back.

 

But to me that was the whole point of QE Infinity. It remains obvious, if you have been following the recent checkered economic data, that the country is still not on a firm footing.  Corporations, given the conflicting signals that they are getting out of Washington while struggling to compete in an uncertain economic environment, need that Fed backing in order to continue to invest.

 

And yes, the stock market was at record highs last month but who is to say that level was unwarranted? If businesses, large and small, do follow through with their investment plans, the economy and employment will grow and the levels of the stock market will, in hindsight, have been a bargain at May's levels. I hope someone at the Fed is reading this.

 

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.