Who Benefits When the Fed Floods the System with Liquidity?

When the Fed floods the system with liquidity, or executes some other transaction to reduce risk in the financial system, the primary beneficiary is not the industry targeted by the Fed.  Rather, the biggest winners are the hottest sectors, both prior and after the Fed's actions.

For example, when Easy Al took interest rates down to 1% and held them there for a very long time, it did not stop the Nasdaq from falling 77%.  Instead, the liquidity flowed into housing, bonds, commodities and various other asset classes.

This financial truism reasserted itself in the Fed's actions from September to March, culminating in the bail-out of Bear Stearns (BSC), which was all done to reduce systematic risk in the financial system. 

For certain, spreads have come in for credit products, though the cash market is still broken and borrowing from the Fed's various facilities have accelerated for the commercial banks.  However, consider the performance of the stocks for the following companies since the end of March:
 

• American International Group Inc. (AIG)  -17%

• Citigroup (C) 1%

• Bank of America (BAC) -11%

• Lehman (LEH) -10%

• Wachovia Bank (WB) -12%

In fact, the KBW Bank Index [BKX] was down 5% during that time.  Remember, the Fed was acting to avert a crisis in the financial system.

Now take a look at the performance of a few momentum favourites during those same two months:
 

• Apple (AAPL) 30%

• Google (GOOG) 31%

• Potash Corporation of Saskatchewan (POT) 31%

The genesis of this post was the performance of the coal industry, of which there are a couple hundred years of known supply of coal in the United States.  This is the performance of various coal stocks over those same two months:
 

• Arch Coal (ACI) 56%

• Consol Energy (CNX) 49%

• Massey Energy (MEE) 94%

• Patriot Coal (PCX)  155%

• Peabody Energy (BTU) 52%

• Walter Industries (WLT) 54%

The biggest beneficiaries of the Fed's actions have been the hottest sectors. 

Disclosure: I own shares in Patriot Coal.

Comments

[adan]

i wish i was the biggest first beneficiary of the fed's actions

i promise i'd do good with it :-)

[theinvestingspeculator]

Who doesn't benefit? The country long-term! Pumping money into the economy is a get short-term bandaid but long-term it will cause many more problems. Look at how high commodity prices are right now. George Soros thinks it is a bubble. I write about it @ theinvestingspeculator...

[Bear StocksReport]

Lately, all the excess liquidity seems to be helping commodity ETFs like GSG, DJP and DBC.

[NormanLepoff, M.D.]

Good article and comments. Thanks.

[windinmyface2]

I think these bail outs have gone far enough, probably should never have started, but who can say, but its time to stop.

[misterchan]

Speculator - Had you invested in thosecommodities, you probably would have benefited monetarily. I did.

[Takayama]

The losers are the prudent savers and those affected by inflation, especially the poor and the elderly. I think CAPITALISM has been badly abused by the greed of corporate America.

[Fool MeAgain]

The FED steals from the poor and gives it to the rich. There's no use saving money. The name of the game is to borrow as much as you can and invest in someting that yields more than the borrowed cost. If you bet wrong, claim bankruptcy wait a few years and try again.

[windinmyface2]

If you think the Fed steals from you now, what do you think will happen if Obama gets in the White House. It will be the begining of the New American Communist Party. Instead of taking 30% of our Stock profit, they might take 50%, and we will be paying 50% to 70% in tax's especially if we get national health care. If this happens, we might as well quit our jobs, and go on welfare, and get food stamps, it would be cheaper. I sure wish Bob Barr had a chance.

[Brianoh]

"when Easy Al took interest rates down to 1% and held them there for a very long time, it did not stop the Nasdaq from falling 77%. Instead, the liquidity flowed into housing, ..."
The dotnet bubble had already burst at that point and the Nasdaq had lost 50%+. The interest rate cuts were to stop the Dow and S&P falling to realistic levels. These cuts began in 2001. The Dow had risen 10 fold (1000%) in 13 years up to its high of 12000 and was then falling. The liquidity did flow into housing of course and cause the bubble.

[Adamsamo]

Obama won't have to raise taxes. The govt. prints money until the dollar loses most of its value and then we can try to work out of a depression that was caused by a lack of oversight in the first place. So you can choose your own poison. Higher taxes or run a deficient such as George Bush has done and got us in the mess that we now find ourselves.


On Jun 05 01:38 AM windinmyface 2 wrote:

> If you think the Fed steals from you now, what do you think will
> happen if Obama gets in the White House. It will be the begining
> of the New American Communist Party. Instead of taking 30% of our
> Stock profit, they might take 50%, and we will be paying 50% to 70%
> in tax's especially if we get national health care. If this happens,
> we might as well quit our jobs, and go on welfare, and get food stamps,
> it would be cheaper. I sure wish Bob Barr had a chance.

[Kunst]

There are 3 choices:
1. Raise taxes to cover expenditures.
2. Cut expenditures to fit in tax revenues.
3. Spend more than your tax revenue and borrow the difference.

Which one we as a nation have been doing, not just for years but for decades, is obvious to all. It has accelerated in recent decades:
* When Reagan took office, our national debt was $1 trillion.
* When Bush I left office 12 years later, it was $5 trillion.
* In Clinton's 8 years, it rose to $6 trillion.
* By the time Bush II leaves office, it will be at or close to $10 trillion.

An honest solution: Congress and the President decide how much to spend, and the federal income tax rates are automatically indexed up or down to produce a balanced budget (and maybe even pay back a little of that debt).

[statePoet1775]

Ron Paul understands monetary policy. He will take us prudently and moderately to an honest monetary system. Please write him in this Nov. so he can't be ignored in 2012.