Since 2008, the Federal Reserve and the United States government have poured almost $1 trillion into the financial markets in order to endorse banks inherit credit problems. By providing liquidity, the government guaranteed illiquid assets such as Over-the-Counter securities in hope to stabilize the markets and lessen any possible repercussions. Strengthening a weakened Banks balance sheet should have allowed them to provide more loans to businesses and consumers, as we all know from basic Economics. And with Federal Funds almost at zero percent, banks should have no problem giving out loans and collecting the spread from giving and receiving “free money”. So why aren’t banks giving out loans to increase the money supply which would lead to a real growth in GDP?
Banks are still uncertain on whether the financial markets have actually stabilized and are unsure what type of risk counterparties and customers may potentially have. This means that local businesses are not receiving loans because of inconsistent revenue streams and unemployment is so high that individuals still cannot be trusted to pay credit card or mortgage payments on time. So Banks are holding billions of dollars on the sidelines, not ready to loan it out or invest in securities, which is now having a large effect on the economy. Everyday cash is sidelined, price erosion begins to take place and effect everything from consumer goods to real estate even more, which means tomorrow may possibly be cheaper than today, so why invest today? This is the reason why Banks are so inclined to hold on to their cash and wait for the opportune moment to invest, but that should not stop you. An individual investor can still profit in today’s market by diversifying against systematic risk.
First, no matter how large your portfolio is you should begin to increase your cash position during uncertain times if you want to protect some of your principal. This also allows an investor to make a purchase later on if security prices fall and begin to look attractive. Some Economists are predicting that the Federal Reserve will increase rates in the Fourth Quarter (2010) or First Quarter (2011) and if that occurs we will see a large inflow of cash in the U.S. economy. Banks and Foreign investors will have more of a reason to invest in the U.S. Dollar and Bonds because they will get a higher and safer return here than in other countries. As an individual you can purchase Government Bonds or rollover short-term Certificate of Deposits (CDs) with all of the cash you have, once interest rates increase of course.
In the meanwhile, if you are willing to take some principal risk it could be a good idea to invest in Gold or long-term Treasuries. Purchasing an Exchange-Traded Fund (ETF) can allow an investor to access these markets with more ease than before. SPDR Gold Trust (Ticker: GLD) and the iShares Barclays 20+ Treasury Bond (Ticker: TLT) would be the most ideal investments for a risk averse investor during deflationary times. TLT has a yield around 3.75% and both of these ETF’s have had very high positive returns in the last six months especially during this unstable market. By diversifying into low risk investments and hedging for future risks, an investor can protect their principal and beat the market effortlessly.
Disclosure: Vijar Kohli has no positions in TLT, GLD, or any of the securities mentioned above. This is neither a buy or sell recommendation; any investments made should be consulted with a financial advisor or individually researched in accord to the Investor’s risk level.