cawacko
Well-known member
I share the same sentiments as this author regarding the Fed induced asset bubbles and the huge challenge we face having to unwind everything here. If just printing money and keeping rates at zero had no negative repercussions we would never stop doing it.
Opinion: Stocks could crash if the Fed’s Yellen can’t perform a miracle
Can she and central bank policy makers really drain trillions of dollars in liquidity without harming the economy?
Investors have bought into what some bankers have been calling the “immaculate conception” thought up by a group of humans led by Federal Reserve Chairwoman Janet Yellen.
Does anyone see the danger to their money in believing that Fed policy makers can pull off such a miracle? The miracle, of course, is draining trillions of dollars in liquidity from the financial system without causing harm to the economy or securities.
A chart
Please click here to see a chart of the Fed’s total assets. Notice how they ballooned from under $1 trillion to $4.5 trillion. The continued excitement in the stock market today shows that investors believe the Fed will execute its plan to unwind its massive balance sheet in a manner that will enable the stock market to continue its march upwards.
The Fed’s balance sheet primarily consists of bonds that it bought in a program known as quantitative easing. The Fed’s purchase of bonds drove interest rates to artificially low levels — record lows, in fact. Low rates, in turn, have artificially inflated prices of bonds, stocks and real estate.
The Fed can unwind its balance sheet by selling the bonds or simply letting the bonds run off. The Fed prefers the latter. “Run off” simply means that when the bonds mature, the proceeds are not reinvested. If the Fed were to sell the bonds, the supply could depress bond prices and raise interest rates. Quickly rising interest rates could cause a recession in the economy and a crash in the stock market.
Translating mumbo jumbo into English
Let’s set aside the economic mumbo jumbo and think clearly in plain English. The Fed created trillions of dollars out of thin air that inflated stock prices. Now the Fed is going to get rid of trillions of dollars that it created yet investors think stock prices will continue to rise.
Investors have simply forgotten that there is no free lunch. A free lunch is exactly what investors are expecting.
What could go wrong?
The Fed has tight control of short-term interest rates, but long-term rates are a different story. As the unwinding proceeds, the plausibility of the Fed losing control of long-term interest rates should be of concern to investors.
The stock market has jumped by about 250%, in large part because of the liquidity created by the Fed. Stocks compete with bonds. Due to artificially low interest rates on bonds, a big part of the move in stocks is not due to higher earnings but to price-to-earnings (P/E) expansion. It is conceivable that in the future we may see P/E contraction if long-term interest rates rise.
Why must the Fed unwind?
If the Fed does not unwind its large balance sheet, it risks much higher inflation and, more importantly, stocks and real estate that would enter a giant bubble. Ultimately, all bubbles burst, causing a lot of pain.
What to do now
There is no immediate danger, and there is still money to be made in the stock market. But it is important for investors to be on extra alert as the Fed attempts to achieve this immaculate conception.
Investors may consider slowly building some hedges. The simplest hedge is to not be fully invested and hold a fair amount of cash. For those who do not mind some sophistication, hedges can come in the form of inverse ETFs against broad-based ETFs such as S&P 500 ETF SPY+0.17% Nasdaq 100 ETF QQQ+0.22% and small-cap ETF IWM+0.08%
Investors can also selectively consider near-zero cost option collars. Gold, silver and miner ETFs such as gold ETF GLD-0.18% silver ETF SLV-1.2% and miner ETF GDX-1.1% may also act as hedges, but the timing of their purchases needs to be carefully orchestrated. Another source of possible hedges are inverse bond ETFs such as TBF+0.62% and TBT+1.29% or option hedges against a popular Treasury ETF TLT-0.63%
Reproduced below is the “what to do now” section from the Morning Capsule that is provided daily to subscribers to The Arora Report:
“It is important for investors to look ahead and not in the rearview mirror.
“Consider continuing to hold existing positions. Based on individual risk preference, consider holding cash or Treasury bills 18%-28%, short- to medium-term hedges of 15%-25%, and very short-term hedges of 15%.
“It is worth remembering that you cannot take advantage of new upcoming opportunities if you are not holding enough cash. When adjusting hedge levels, consider adjusting partial stop quantities for stock positions (non-ETF); consider using wider stops on remaining quantities and also allowing more room for high-beta stocks. High-beta stocks are ones that move more than the market.”
http://www.marketwatch.com/amp/story/guid/BA657F58-673F-11E7-819C-E53F1BEA2AD2
Opinion: Stocks could crash if the Fed’s Yellen can’t perform a miracle
Can she and central bank policy makers really drain trillions of dollars in liquidity without harming the economy?
Investors have bought into what some bankers have been calling the “immaculate conception” thought up by a group of humans led by Federal Reserve Chairwoman Janet Yellen.
Does anyone see the danger to their money in believing that Fed policy makers can pull off such a miracle? The miracle, of course, is draining trillions of dollars in liquidity from the financial system without causing harm to the economy or securities.
A chart
Please click here to see a chart of the Fed’s total assets. Notice how they ballooned from under $1 trillion to $4.5 trillion. The continued excitement in the stock market today shows that investors believe the Fed will execute its plan to unwind its massive balance sheet in a manner that will enable the stock market to continue its march upwards.
The Fed’s balance sheet primarily consists of bonds that it bought in a program known as quantitative easing. The Fed’s purchase of bonds drove interest rates to artificially low levels — record lows, in fact. Low rates, in turn, have artificially inflated prices of bonds, stocks and real estate.
The Fed can unwind its balance sheet by selling the bonds or simply letting the bonds run off. The Fed prefers the latter. “Run off” simply means that when the bonds mature, the proceeds are not reinvested. If the Fed were to sell the bonds, the supply could depress bond prices and raise interest rates. Quickly rising interest rates could cause a recession in the economy and a crash in the stock market.
Translating mumbo jumbo into English
Let’s set aside the economic mumbo jumbo and think clearly in plain English. The Fed created trillions of dollars out of thin air that inflated stock prices. Now the Fed is going to get rid of trillions of dollars that it created yet investors think stock prices will continue to rise.
Investors have simply forgotten that there is no free lunch. A free lunch is exactly what investors are expecting.
What could go wrong?
The Fed has tight control of short-term interest rates, but long-term rates are a different story. As the unwinding proceeds, the plausibility of the Fed losing control of long-term interest rates should be of concern to investors.
The stock market has jumped by about 250%, in large part because of the liquidity created by the Fed. Stocks compete with bonds. Due to artificially low interest rates on bonds, a big part of the move in stocks is not due to higher earnings but to price-to-earnings (P/E) expansion. It is conceivable that in the future we may see P/E contraction if long-term interest rates rise.
Why must the Fed unwind?
If the Fed does not unwind its large balance sheet, it risks much higher inflation and, more importantly, stocks and real estate that would enter a giant bubble. Ultimately, all bubbles burst, causing a lot of pain.
What to do now
There is no immediate danger, and there is still money to be made in the stock market. But it is important for investors to be on extra alert as the Fed attempts to achieve this immaculate conception.
Investors may consider slowly building some hedges. The simplest hedge is to not be fully invested and hold a fair amount of cash. For those who do not mind some sophistication, hedges can come in the form of inverse ETFs against broad-based ETFs such as S&P 500 ETF SPY+0.17% Nasdaq 100 ETF QQQ+0.22% and small-cap ETF IWM+0.08%
Investors can also selectively consider near-zero cost option collars. Gold, silver and miner ETFs such as gold ETF GLD-0.18% silver ETF SLV-1.2% and miner ETF GDX-1.1% may also act as hedges, but the timing of their purchases needs to be carefully orchestrated. Another source of possible hedges are inverse bond ETFs such as TBF+0.62% and TBT+1.29% or option hedges against a popular Treasury ETF TLT-0.63%
Reproduced below is the “what to do now” section from the Morning Capsule that is provided daily to subscribers to The Arora Report:
“It is important for investors to look ahead and not in the rearview mirror.
“Consider continuing to hold existing positions. Based on individual risk preference, consider holding cash or Treasury bills 18%-28%, short- to medium-term hedges of 15%-25%, and very short-term hedges of 15%.
“It is worth remembering that you cannot take advantage of new upcoming opportunities if you are not holding enough cash. When adjusting hedge levels, consider adjusting partial stop quantities for stock positions (non-ETF); consider using wider stops on remaining quantities and also allowing more room for high-beta stocks. High-beta stocks are ones that move more than the market.”
http://www.marketwatch.com/amp/story/guid/BA657F58-673F-11E7-819C-E53F1BEA2AD2