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posted on 03 December 2016

How To Invest When The Fed Destroys Capitalism

by David Zeiler, Associate Editor, Money Morning

Money Morning Article of the Week

With its easy-money policies increasingly ineffective, the Federal Reserve is now devising a new, even more dangerous strategy - one that threatens the very nature of capitalism itself, which is private ownership of the means of production.

skull.money.balance

You see, the U.S. Federal Reserve fired all its bullets dealing with the fallout from the 2008 financial crisis. That has left the central bank with virtually no policy tools to combat the next major economic setback.

That's why the Fed is trying to boost interest rates. At just 0.50%, the Federal Reserve is expected to raise it to 0.75% in December. But that leaves little maneuvering room for fighting the next crisis.

And the quantitative easing (QE) bond-buying program has left $2.5 trillion of federal debt on the Fed's balance sheet. The Fed can't really go back to that well, either.

That's why the Fed is floating another idea…

The Federal Reserve Is Looking at This Radical Option

At some point in the not-so-distant future, the Federal Reserve will start buying stocks, ostensibly to boost the U.S. economy.

We know this because it came up recently in a House Financial Services Committee hearing in late September. Committee member Mick Mulvaney, R-S.C., asked Fed Chair Janet Yellen if the Fed was "looking as the possibility of adding the purchase of equities to its toolbox."

Yellen replied that by law the Fed isn't allowed to purchase equities, but noted that "longer term issues and difficulties we could have in providing adequate monetary policy" could cause Congress to reconsider making it possible.

Days later, former Treasury Secretary Larry Summers told a Bank of Japan conference that central bank purchasing of a "wider range of assets on a sustained and continuing basis" is worthy of "serious reflection." According to Money Morning Chief Investment Strategist Keith Fitz-Gerald:

"Government officials have been mulling this for years despite the fact that this is going to shock many investors. It's in their interest."

In fact, many suspect the Fed intervenes in the stock market surreptitiously now by purchasing stock index futures. Buying shares of stocks outright would simply be the next step.

Other central banks already have set the precedent.

The Bank of Japan has been buying stocks since 2010, although the policy accelerated under BOJ Gov. Haruhiko Kuroda in 2013. A Bloomberg study in April found that the combination of exchange-traded fund purchases and individual stock purchases had made the Bank of Japan a top 10 shareholder in 90% of the Nikkei 225 stock average.

The Swiss National Bank (SNB) has been investing its foreign currency reserves into stocks for more than a decade, ramping up the program in 2010 in an attempt to weaken the Swiss franc.

federal reserve

All the shares are in non-Swiss companies, with the majority invested in U.S.-based stocks. According to Bloomberg data, the SNB held $62.4 billion worth of stock spread among more than 2,500 U.S. companies as of the end of September.

Some economists believe the European Central Bank (ECB) will be the next to jump on the stock-buying bandwagon. The ECB is running out of bonds to buy, particularly the coveted German bunds.

It's easy to imagine a U.S. Congress, eager for a new source of economic stimulus, granting the Fed the ability to follow the lead of the world's other central banks. The more common stock buying becomes elsewhere, the harder it will be for both Congress and the Fed to resist - making it practically inevitable.

But according to Fitz-Gerald, it's a terrible idea that would "undermine the very essence of capitalism."

Why the Fed Buying Stocks Will Destroy the System Its Trying to Save

While the influx of new cash into the stock market would jolt prices higher, that's not necessarily a good thing when a central bank is behind it.

"A Fed that buys stocks would completely distort the market," Fitz-Gerald said, noting that it would cripple the essential function of price discovery - meaning what a company is really worth. In fact, continues Fitz-Gerald, the primary criteria for which companies to buy "would become solely a function of liquidity because only the biggest and most liquid stocks will be capable of absorbing such a massive influx of money".

The Fed's shopping list would likely resemble the SNB's largest holdings, which include

Apple Inc. (Nasdaq: AAPL), Facebook Inc. (Nasdaq: FB), AT&T Inc. (NYSE: T), Johnson & Johnson (NYSE: JNJ), Pfizer Inc. (NYSE: PFE), and many more.

In addition to artificially inflating prices, Fitz-Gerald said the Fed buying would also feed volatility. Fitzgerald points out:

"If the Fed is buying stocks, some shares will never be traded again - effectively the Fed will be taking supply off the shelf,. With fewer shares being traded, volatility will skyrocket."

Then there's the sticky question of having a central bank as a major shareholder with enough votes to influence corporate policy.

The SNB, for example, has a 0.28% stake in Facebook - more than the 0.17% of publicly traded FB stock owned by CEO Mark Zuckerberg (although much of his stock belongs to a different class).

What's more, even partial Fed ownership of companies raises issues of the government's ability to exert control over private industry - an uncomfortable step toward socialism, no matter how small.

Finally, propping up the stock market and/or stimulating the economy are not the Fed's job. The central bank has a dual mandate to seek maximum employment and manage inflation. Any other economic objectives are Washington's responsibility.

As destructive as this Fed move will be for stocks, it doesn't mean investors should bail out. In fact, Fitz-Gerald said, there is a way to profit from this…

How to Prepare for When the Fed Starts Buying Stocks

While having the Fed as a player in the stock market will make equity investing much more chaotic and risky, we do know one thing - prices will rise, particularly of large, well-established companies. According to Fitz-Gerald:

"Effectively, investors are going to have to front-run the government. Ordinarily that's a bad thing, but in this case you know their playbook ahead of time. We know based on experience that they're going to go after the biggest, most liquid stocks first. That's where you need to be before this gets started."

Investors can also count on something else. Whatever excuse the Fed gives for jumping into the stock market, it will have a tough time reversing course. Fitz-Gerald said:

"They won't be able to stop because cheap money is addictive. Just ask any of dozens of economists, political hacks, and apparatchiks who assured a nervous public during the financial crisis that low interest rates and stimulus would be short-term measures… if you can find one,"

That means the distortion of the markets, once it begins, will go on indefinitely.

Fitz-Gerald would know. He's one of only a handful of analysts to have seen both the dot.com crash and 2008 financial crisis coming ahead of time and to have helped millions of investors successfully navigate them both. He says:

"Barring massive changes, our government can no longer outrun an economic meltdown, but that doesn't mean they won't try using more smoke and mirrors - like buying equities."

The best way to prepare for that is to do what he's been helping Total Wealth and Money Map Report subscribers do for nearly a decade, "by getting ahead of the Fed's next move and positioning in the large, quality stocks they're going to have to have."

It's a cautionary tale, says Fitz-Gerald, in that investors can see this as a burden or an opportunity.

And "opportunities are always more profitable."


To gain access to Fitz-Gerald's money-making strategies and his free Total Wealth newsletter, just click here.


Follow me on Twitter @DavidGZeiler or like Money Morning on Facebook.


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