The Shot Across The Bow

Two weeks ago we talked about the upcoming Federal Reserve meeting in my column “What’s For Breakfast?” This week I want to talk about the results of that meeting and the impact it has had on the financial markets.
This past week I finished teaching a very popular course for senior citizens on financial issues at Cape Cod Community College. In the class we discussed various types of risks that traditionally have impacted our investment decisions, such as, interest rate risk, market risk, business risk, and inflation rate risk. With my most recent class, we discussed yet another risk, one that is relatively new. Let me now introduce to you, my readers, the Fed Risk.
Whether we are retired or hoping to be retired one day, our choices about the preservation and growth of our hard earned savings are now based in large part on the decisions that are made by less than 20 folks who meet only 8 times a year.
Think about this with me for a second. Since 2008/2009, the Federal Reserve, (the “Fed”) has become so engrained in our financial lives that before we make any financial or investment decision, we often speculate on what the Fed will do next. It could be the raising or lowering of interest rates, or the slowing of the $85 billion being pumped into our financial systems. Whatever it is, the fundamentals of investment analysis, such as corporate earning, now play second fiddle. Rather, as I explained two weeks ago in the column “What’s For Breakfast?” our financial future often hinges on the mood of the governing board of the Federal Reserve, particularly Ben Bernanke.
Cutter Family Finance readers are well informed about the risk of this situation. You were cautioned about it in the April article, “You Have Been Warned”, and a few weeks later in the article “When Will The Music Stop?” You, my readers, understand that once the Fed turns off the money spigot, the house of cards will come crashing down.
Let me prove my point. About a month ago the Fed released the minutes from its April meeting (1). In this meeting, they discussed a potential slowdown in bond buying (which means the flow of money, or QEternity, will begin to slow down). What happened? The markets went crazy. After the Fed’s June meeting, Fed Chairman, Ben Bernanke reinforced the idea they would taper off the bond buying (turn down the spigot), possibly in the near future (2). The market addicts went crazy and once again the market itself saw enormous downward pressure. As we know the more crack an addict has, the more crack an addict wants. The more our financial markets are addicted to the drug of newly printed money and Fed bond buying, the more it needs.
Could it be possible that this market volatility is simply a knee-jerk reaction from investors and they have greatly exaggerated the role of the Fed’s spigot? Possibly, but I doubt it. I suspect investors to be right on the money.
It is also noteworthy that the market and Fed “experts” who have been so very positive about the U.S. economy and bullish on the markets and have been telling us for months how great things are (I assume many of them work for banks, but I don’t have any substantial proof of that, it’s just a well-educated guess), have not been so vocal in the past couple of weeks. This is an indication to me that they are no longer confident that the U.S. economy has recovered.
The Fed, upon seeing what its statements have done to the markets and investors’ confidence, spent the last several days trying to take back what it said. They are now telling us that as long as we have a weak economy, not too worry, they will still be keeping that spigot wide open, at least for now. But this doesn’t mean you, my readers, should relax. The Fed’s shot across the bow, and the market’s reaction, was an early warning sign of what is to come. The Fed will slow down its bond-buying program, and when it does, expect the wheels to come off this market bubble.
Our markets have been built on bubbles in the past and this situation is no different. During the last four years, the gains in the markets have relied on the premise that Uncle Ben would keep spending and be involved in our financial lives forever. The idea that this spending is slowing down has now caused investors to look at the man behind the mask and question simple economic fundamentals. What folks are seeing is that the underlying economy is not as strong as we have been told. 1.8% Gross Domestic Product (GDP) growth for the first quarter of 2013 (3)? 1.8% growth is not good when it includes $85 billion a month in new Fed spending driving up huge government deficits. Flat and falling wages is extremely troubling to an economy that depends upon rising wages (4). Wrap increasing taxes, healthcare costs, and educational expenses into the picture, and our financial outlook may not be so rosy for investors, especially when Uncle Ben is preparing to turn off the spigot.
So here’s what I tell my clients. Slowing the Fed spending might not be what many folks want, but it’s exactly what we need. We are simply delaying the day of reckoning if we continue to rely on the Fed’s QEternity (the continuous spending of money) and to avoid the real issues we face. As I have explained, we have seen these types of market situations before with the Tech Wreck of 2001-2002 (5) and the Mortgage and Lending bubble of 2007-2009 (6). For these reasons, investors need to be actively managing their assets to be defensive in troubling times and opportunistic in good times. Simply put, a buy and hold strategy will not work, as many investors were victims of during the Lost Decade of 2000-2010 (7).
Stay vigilant, stay informed, your financial and future depends upon it because You Deserve More!