Why Are You So Afraid Of The Fed? Stop The Fear Mongering

Jun. 12, 2013 8:36 AM ETSPY, DIA, QQQ15 Comments
Convex Strategies profile picture
Convex Strategies

I'm not ashamed to admit I've been wrong. I once wrote an article here on SA advising people to "short and fear" the US growth story. I got my face ripped off, so to speak, on some poorly-timed index shorts, and missed out on the fatter part of this bull market. I was fairly new to the game, didn't understand monetary policy, and was biased. It happens.

What can't happen (though it does, all to often), however, is the failure to adapt and learn. Over the past few weeks, there's been a noticeable uptick in the volume of ultra-negative commentary hitting the financial blogosphere. I recently came across this article from a fellow SA contributor, in which he argues that the Fed may lose control of the bond market, financial institutions are highly leveraged, and we're on the verge of a market crisis.

This sort of negative commentary is unfortunate, and it's the same interpretation of government policy and banking economics that has kept individual investors out of one of the greatest bull markets in history. The negative viewpoints expressed in strongly anti-Fed posts generally stem from a misunderstanding of monetary policy. There are plenty of well-reasoned analyses that conclude that the ultimate outcomes of unprecedented monetary policy could be quite negative, and that there is reason for caution - fair enough.

What isn't fair, especially to individual investors who should be approaching capital markets as a way to build long-term wealth via sensible investments, is espousing the need to be fearful and championing for a "market crash." Paul Farrell over at Marketwatch has been doing this for several years, recently calling for a perilous market crash by year's end, going so far as to say we're going to see "a worse plunge than 2008."

The rationales for this doomsday hypothesis? Such gems as Peter Schiff is "doubling down on his doomsday hypothesis," Warren Buffett said in 2008 that we'll eventually have another bubble on our hands, and InvestmentNews' forecast for a bond market collapse. You literally can't make this stuff up. Guys like Schiff and Farrell have been rooting for "gold to $10,000/oz!" and shouting as loud as they can, "America is bankrupt!" for years, only to be proved wrong by price action again and again.

These folks are angry, biased, and misinformed. Worse still, they don't adapt. They refuse to even entertain the notion that they're wrong about the effects of QE. They're obsessed with "The end," and play it off as if their analyses are simply calm, statistically driven predictions that are certain to be correct.

You Don't Understand QE

If you're certain gold is headed to $5,000 or whatever round number sounds high, or that the Fed is going to collapse the bond market or cause runaway inflaiton, you're not getting it.

Let me preface this with the following: as a casual investor, or at least someone who doesn't have a comparable track record, you have to at least start your analysis by giving the benefit of the doubt to people like Ben Bernanke. A simple appeal to authority is absolutely justified when it comes to something as complex as monetary policy. A lot of people, for whatever reason, don't want to hear that. They don't want to hear that Ben Bernanke is way smarter than them, or that he's not a part of the illuminati. Seriously, a little modesty goes a long way.

I had someone tell me a while ago that "they trusted the economists in the USSR, and look how that worked out." What? Are we in the USSR? Instead of engaging in conspiracy theories, go for a walk. It'll do you some good.

With regard to policy, people need to understand that "there is no correlation between the Fed printing and the money supply," as so eloquently outlined by Mark Dow at Behavioral Macro. Mr. Dow goes on to note the lack of correlation between base money (what the Fed prints) and inflation.

"How could this possibly be true?"

The takeaway is that reserves remain in a closed circuit, and they shouldn't be mistaken for credit, the true driver of inflation. Mr. Dow explains:

The Federal Reserve only provides liquidity. The amount of liquidity it puts in the reserve system has no direct impact on the issuance of credit by banks or shadow banks. Only banks and shadow banks can create credit. And they lend either out of cash on hand or by repo-ing treasuries, mortgages, or deposits, if cash on hand is insufficient. And collateral that is pledged once can be pledged over and over and over (collateral chain). So, even though credit increases, the total amount of banking reserves on deposit at the Fed remains unchanged (though composition across banks may change).

The Fed is merely a catalyst for the expansion of credit, not the source of credit. Thus, the effects of bond buying on the part of the Fed are largely psychological. When QE ends, we'll likely still have low interest rates facilitating economic growth, and with housing and autos continuing to boast strong growth, leading indicators look pretty solid.

If the Fed's next announcement sends stocks plummeting, start looking for bargains. The opportunities likely won't last very long - the Fed has been telegraphing this policy evolution for quite some time.

Markets Might Crash Someday

Look, stocks could crash 20% tomorrow. They'll certainly tank one of these days. I don't see why that should scare you, nor do I see how the knowledge that markets will go down violently for some period of time at some point in the future provides you with an investment edge. You're not unique for "knowing this."

For reasons I explain here, there is also no need to be worried about dollar debasement or the US deficit. Stop being scared of "some point in the future." Invest away, but do it with a longer-term focus and if you don't think you're smart enough to pick good investments or you just aren't willing to put in the time, then average in to an ETF that provides you with broader market exposure (SPY). I see plenty of bargains still out there, such as Ford (F) and Wells Fargo (WFC); I think financials and cyclicals will continue to outperform.

It's such a shame, really, to see innocent investors who don't know better scared by "uncertainty" or the potential of a market crash. The commentators feeding you this stuff should familiarize themselves with the aftermath of every major crash we've had in this country. They've all been buying opportunities. Here's to hoping we crash.

Disclosure: I am long F, WFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Convex Strategies profile picture
Convex Strategies is a private investor looking for high upside investments with definable downsides.
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