Quantitative easing (QE) programs, courtesy of the Federal Reserve, have pushed cash into Primary Dealer accounts at the fastest rate in history. This has been massively bullish for equities over the past four years, as the Primary Dealers used some of that cash to bid up equity prices. This will likely continue until the Fed significantly curtails or discontinues its QE operations.
U.S. stock indices have been marking time during the past four weeks, gauging "talk" about whether Chairman Ben Bernanke will slow down his printing presses. Notwithstanding the rumors, we doubt that QE tapering is on the horizon.
In our view, unless the Fed stops funneling money to the Primary Dealers, which we deem doubtful, pullbacks in stock prices are likely temporary pauses along an upward path. Therefore, in both of our Virtual Portfolios (Value and Put Selling), we are remaining long and unhedged.
The Fed Is Unlikely to Taper
America's national debt now runs approximately $16.5 trillion. President Obama use his power to hold rates down because the cost of higher debt service would devastate his political agenda.
Bernanke does Washington's bidding so he is probably just "talking down" market enthusiasm by leaking news of a coming "taper." In this fashion, he uses fear of reduced QE to contain equity prices without actually changing the Fed's policy.
During the fiscal cliff debate in December 2012, people assumed tax rates would be much higher in following years. That precipitated an enormous amount of accelerated income and dividend payments that would have been made in 2013. Because of the higher income booked in Q4 2012, estimated tax payments due January 15, 2013, soared. This reduced the size of the expected Q1 deficit.
Bernanke's primary mission is to monetize the debt created by federal budgets that far exceed revenues. We see no way for the Fed to reverse course on QE regardless of the whispers to the contrary.
The Fed has painted itself into a corner and there is no way to unwind the QE trade without debt service costs eating everyone alive. Unwinding would cause interest rates on U.S. sovereign debt to soar, because no one would buy debt at interest rates the government could manage. For every one percent rise in interest rates, there would be an estimated $80bn in increased annual debt service costs at the federal level. The payment of interest would overwhelm all other spending.
Our article, In Love with TINA (as in, "There Is No Alternative"), explains why stocks are attractive. There are no viable competing investments if you seek to protect your life savings' long-term buying power. Absent a major change in policy, a full allocation to equities seems reasonable, as does avoiding fixed income. Bonds today are in a bubble, and a pop of the fixed income bubble is apt to be louder and more astonishing than anything we will see in the equity markets.
Chart by Lee Adler of the Wall Street Examiner.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.