Wednesday, April 14, 2010

The Fed's Newest Bubble

Well it looks like the Fed has done it again.

They have successfully created another bubble. You can call this one the Equity Bubble. Once again it was done using the same toolbox of low interest rates.

It's amazes me when I watch this country keep making the same mistakes over and over again. Greenspan has been vilified post housing bust for keeping rates too low for too long in response to the last recession at the beginning of the decade.

Yet me have managed to do the same exact thing all over again before we have even fully recovered from the last time we made the same stupid mistake.

Any reputable economist will tell you that keeping interest rates too low for too long creates the perfect environment to create bubbles. The massive amounts of money created by such policy eventually begins to flow somewhere. This time it landed in stocks.

When looking at our previous bubbles created by our two decade old Ponzi finance system(tech, housing, and now stocks) they all had one thing in common: The ability to borrow money at extremely low rates.

So Why Stocks This Time?

In my opinion its multi faceted.


The banks have basically found their version of heaven:

- Hide their losses via fraudulent accounting

- borrow at practically zero.

As a bank in this environment you are going to make a fortune when you borrow at zero and lend to a home buyer at 5% or buy 30 year bonds that pay a 4.6% yield. It's almost impossible to lose money in such a rate environment when you are allowed to hide your losses with "hide the sausage" accounting.

Eventually, a large piece of this newly created money then inevitably begins to flow into stocks.

This got the stock bubble started. Then(like any other successful bubble) you need to suck everyone else in.

How do you orchestrate this if you are the Fed? Take away all other investment options.

Investors(especially senior citizens) are desperate for yield. Many of the elderly depend on it. By dropping rates to zero, the Fed has wiped out CD's, money markets, and treasuries as solid yielding investment options.

This essentially forces both the public and fund managers into buying stocks and junk bonds in a desperate chase for yield because the "safe" investments pay them nothing.

Just like the housing bubble: The higher the market goes the more people get sucked in like any other Ponzi scheme.

Eventually, the bubble turns into a euphoria where investors can't get enough until the music stops(which it always does)..

I am not sure if we are into the euphoria stage yet but one thing is for sure: Bubbles never end well.

I find at sad that investors are forced to throw their retirement portfolio into a bipolar market that soars and crashes ever few years.

Just look at the s&p 500 over the past decade or so:

My Take:

Markets aren't supposed to look like this! I believe the rally we have seen in 2009 wouldn't have been nearly as strong if CD rates were at 5% like they have been historically.

Investing in a zero interest rate environment has now changed the whole game. It turns the market essentially into a speculative casino where investors desperately try to find returns.

I bet if you took a poll: 80% would tell you that they hate investing in an environment like this where they are forced to take huge risk in order to find return.

I know it aggrevates the heck out of me.

Who in the hell wants to work all their lives and put their life savings into something that resembles Space Mountain at Disney World? The average person in this country doesn't want to invest in a roller coaster ride that gives them nothing but a couple heart attacks and zero returns when it is all said and done.

The Fed's policies however tell you that they could care less about the average person in this country. It's all about taking care of their Wall St. buddies.

The Bottom Line

I don't know where we are in this bubble but one thing I do know is this:

Buying stocks because there are no other options versus buying them based on valuations is a recipe for disaster.

When was the last time you heard about P/E values on CNBC? Been weeks since I have heard them talk about it. Hell, they probably can't even figure out the real P/E valuations because their is so much crap that's sitting on so many corporate balance sheets that's not being accounted for because of fictitious accounting rules.

God only knows how many worthless bad loans remain valued at 100% on Bank of America's balance sheet.

Don't be fooled folks: Markets that are made ignoring fundamentals eventually end up getting torched.

To be fair and balanced are earnings up? Of course, but look what they are being compared to. The economy virtually stopped from Sept. 2008-March 2009. If you are an average company you should be beating earnings after downsizing and increasing productivity in response to the great recession!

The question is can it be maintained? The answer is No Way Jose IMO.

What's scary is the quarterly earnings are probably going to look good which is going to throw even more investors onto the train we like to call the stock market.

Like any other bubble, this one will blow too and when it does there will be no place to hide because the Fed has used all of it's ammo to create the currentequity bubble.

The way it will blow will be two fold:

- The mark to fantasy game ends and losses are realized.

- Interest rates march higher as the risk of default rises as we continue to play "hide the losses" from the Ponzi finance game that peaked with the housing bubble.

If you are long enjoy the ride but watch out for that cliff that lies straight ahead.

Disclosure: No new positions at the time of publishing


getyourselfconnected said...

JP Morgan said fixed income (bonds) were the big winner as well as trading. Borrow from the FED at 0%, buy whatever treasury offering there is for th spread and presto! Good bond sales and a gain for the banks. Add to this the big boys are trading the same 5 stocks back and forth in a fixed manner and you have some high frequencey trading gains. Unreal.

Jeff said...


Yup. They are also underweight treasuries. I have a post I am working on about that. It may be time to go long bonds for a trade.

flipdippy said...

It's hard to be in cash and metals yet it seems incredibly shortsighted to be in bonds or stocks. The lesson from 2008-9 is any gains can be wiped out in a day or two. I'll let the markets run blindly and wait.

And Jeff, calling the stuff people are chasing "junk" is insulting to junk stocks and bonds. It's more like casinos adding daily lotteries. I mean, ABK? Some of these chinese stocks with dodgy accounting moving to the NASDAQ and jumping 1000%? Jeez.

Said it before but the irony on Wall St is they don't see their own transformation from financial institutions to technology/software firms. Wait until the top executives realize they can pay themselves much fatter bonuses by getting rid of their traders and replacing them with algorithms and programmers. There is fable I believe about a snake or some other creature eating itself. Once the punchbowl is taken away and some of these proposed new regulations go into law it will be game over banksters. Hope you saved your bonuses.

economessed said...

This was an excellent summary. Very well written!

Anonymous said...

This is the exact point I have been making all along. I'm not saying some of the bailout programs have not been a success in preventing a total collapse of the financial system but now not only are we healing the patient but are pumping him up with steroids. I had to laugh when Greenspan was testifying last week, what an absolute joke, what does it matter now whether he kept rates too low for too long, we all know he was a piece of the puzzle so lets not keep rehashing this and fiqure out real viable solutions so that 5 years from now the government is not having to throw billions more at propping the market up until we have printed ourselves into oblivion and are speaking some foriegn language.

Anonymous said...

OK we all agree to a certain extent; so where do we put our hard earned cash other than the stock market and get a descent but safe return? I'm brand new to this site so maybe ideas like I'm proposing have been discussed. I've moved money to Australia banking for 5% CD's. What other ideas are out there.

Jeff said...

Great thoughts all

Going oversees may be the thing to do. Didn't realize Australian CD's are paying that well.

Our whole financial system has become a joke and Flip thats an interesting take on computers replacing traders. Couldn't happen to a nicer group of people:)

What a crazy world we live in.

flipdippy said...

Looking forward to a post tonight.

Hard to get excited about this GS stuff with the timing of the reform legislation going to the floor for a vote next week.

Still, glad to be on the sidelines.

dorchid said...

I've just found this site and appreciate the insight. As a layperson, it's hard for me to read mainstream media's takes on this because there is always a political slant, like they're either sympathetic to Obama (and say the economy is improving) or they're not (and say it's Dooms Day).

I'm a 20-something, I started my Roth IRA a few years ago. The conventional wisdom is that as a long-term investor, I can take more risk and invest more in stocks. Do you think this still holds? Or is the game changed for good?

I've also been thinking about all the Baby Boomers who in the next twenty years or so will be divesting from stocks as they retire into old age. Won't this also affect stock values?

flipdippy said...


you will probably get an answer similar to mine from the other posters, but take this FWIW.

Eventually, yes, there will be a recovery. The problem is it may not be for another 3,5,7,10 years. At some point, equities will be more attractive from a fundamentals perspective, and you can invest feeling safe. We are not there now, by any stretch.

Immediately before that happens, there will be a massive collapse in equity prices which could be due to a number of reasons, which if you read Jeff's postings, you'll see what they are.

Until that collapse, stocks are probably range bound. Nobody knows if that period will last a week, a month, a year, 2 years, etc.

Buying and holding until all the crap in our economy is purged is a failing strategy. The big banks are making their fortunes eating the lunch from using software and liquidity from the Fed to push markets around. They are eating the lunches of most mutual funds, pensions, and hedge funds.

And that is before, as you mention, the boomers who are just now getting their portfolios to where they were in 2008 before the markets collapsed WILL start moving funds into stable assets. They can't afford to suffer through another market tank. They can afford to take lesser returns.

Do your own DD, don't rely on what others say, unless your DD leads you to a similar conclusion. Don't expect you can just buy anything and let it sit and expect it to appreciate.

Probably the best advice to give you is to pay off any debts you may have. You are better served paying off credit cards, student loans, auto loans, than you are putting your money in the casino or in a bank which is insolvent by any traditional accounting measurements.

The most stable stocks to own in an IRA, IMO, are miners. You don't want to own metal ETFs because that is just paper, you don't actually own the metals. And stocks are very risky, be it Apple or Google or Ford or Catepillar or Goldman Sachs.

James B said...

SEC's going after Goldman. Finally!

Anonymous said...

dorchid- I personally think the old rules of investing still apply no matter what is going on with the markets/ economy and they are create a low cost, properly asset allocated portfolio that you are dollar cost averaging into no matter what is happening around you. Market timing is a futile game, just ask most of us on this blog, how many of them put everything in on March 6,2009? I can tell you that I did not, I have been building up cash and have been thinking a correction would happen at any time since Dow 7K. Prime example of that had I been DCA'n into my portfolio then I would have made more then the little bit I bought on the way down in 08. You are young, you can take as much risk as you like with your long term money.
This is a good blog to get a different perspective and I happen to agree with Jeff and many of the posters on where things are headed but there is an old saying, the market can stay irrational longer then you can stay solvent. Too me the market has been overpriced since 1997 and in 3/6/09 it was just starting to get to a fair value where you could start building up but the government buying the s&p and all the other stimulas programs just reinflated it all over again. Is the economy really as good as the stock market says??? This is my point, one never knows where the market is headed next so if you are a long term investor, follow the old tried & true rules.

Jeffrey said...


Glad you are enjoying the sight.

You are right about your ability to take on more risk at your age.

I would be leery of jumping in right now after a 60% rally though.

Stay diversified and wait for a better entry point on equities.

I think the days of buying and holding are over for awhile.

If the fundementals get back to where they need to be then it will be possible to do that again someday.

For now I would be careful and stay conservative.

I couldn't agree with you more about how the baby boomers play into this.

YOu sound like you are way ahead of the game at your age in terms of investment knowledge.

Good luck!

Jeffrey said...

Great advice Fli[p and anon.

Couldn't agree with you more.

JAmes B. Goldman...FINALLY...I will have something up this weekend on this. I expect much more from the SEC in this area.

The pigmen may finally be going down.

Anonymous said...

noticed they just did reverse splits on key short etf's... as much as 10-1 in some cases. jeff: any idea why now?

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