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Playing with Bubbles

As the Fed gives us the gift of yet another bubble, investors need to know how to capitalize on this short term phenomenon and how to prepare for the inevitable burst.

Who wouldn’t give a buffalo nickel to be sitting on top of a hillside on a beautiful afternoon, carefree playing with bubbles? Certainly the Fed and U.S. Treasury are having a blast. Who could blame them? They’re using our money, as well as that of our kids, as soap.

We’ve just gone through 30+ years of a debt induced (leveraging) borrow and spending binge and a massive deleveraging is happening as we speak. This spending spree was driven by the consumption requirements of the young baby boomers in their peak spending years. Now they’re past their spending years and well into their savings years. The federal budget deficit leaped from $187 billion in December 2007 to $1.3 trillion in the 12 months ending August 2010, and is expected to exceed 2 trillion next year. The sad part is that it has had little net effect on the economy because private sector deleveraging more than offset the government stimulus. In simple terms, assets are being lost or destroyed faster than the government can inflate.

All of this money from stimulus or quantitative easing is just going to the large banks, investment banks and corporations which are using it for speculation. It simply allows banks to build up their capital reserves and corporations to refinance their debts or issue new debt, which most don’t need, at low rates. The “hope” is that these beneficiaries will expand production and hire workers. However, there are no jobs and no increased demand from consumers being created from this. The money is merely going into asset speculation, thus creating another bubble. Can stocks rise in a horrible economy? You bet. However never forget, that bubbles always burst, and they never do so when you expect them to.

This bubble is just like the others of the past decade. Back in 2000 the Fed responded to the stock market crash by creating cheap money which led to the real estate bubble. When the real estate bubble burst in 2005, they again created cheap money which led to the last stock market bubble. When that burst in 2008, they just started again and here we are. The Fed has no interest in fixing the root cause, which is lack of demand, just a quick fix to get us past the next election.
Now, the good thing about bubbles is that it drives asset prices higher. For those that got in and out of real estate as well as stocks at the right time, you made a fortune. The same holds true now. For those that know how to participate in the current bubble with the least risk possible and know when to get out, they too will make a fortune. There are definitely good opportunities out there for nimble investors who know what they’re doing, so be the expert or hire one.

Investor Strategy:
Naturally we cannot just sit with money in the bank earning nothing, nor can we afford to stay dormant with an old fashioned buy-and-hold (buy-and-hope) approach. Both are destined for disaster. We must take what the market gives us, when it gives it to us. Finding that "Sweet Spot" is critical. That means getting the very best returns with the least amount of risk possible, and having personal exit strategy. 

Disclosure: "No Positions"