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Where Would We Be Without the Fed?

25 | By Shah Gilani

We’ve arrived. We’re exactly in the middle between here and there.

The problem with being here is the “there” part.

I’m talking about where the markets are and where they’re going next. Is “there” backwards or forwards? Are we coming or going from here?

Before I give you my own forecast, and recommendation, let me say this about that…

Here are the two best forecasts I’ve ever heard:

  • “It will fluctuate,” which was what J.P. Morgan famously answered when asked what the market would do, and
  • “I cannot forecast to you the action… It is a riddle, wrapped in a mystery, inside an enigma,” which is what Winston Churchill famously said, not about the market, but about Russia. (The full first line is, “I cannot forecast to you the action of Russia.”) But you get the picture.

American markets are touching their highs. It’s as if everything is clear and sunny. It’s as if forecasting is as simple as looking out the window and calling out what you see.

It’s clear and sunny. Haven’t you looked outside? If only it was that easy…

But when you do look outside, let’s say, through a window, you only see in one direction. The question can then be asked, is the weather you’re looking at coming or going, or is it here to stay?

America, and indeed the global financial markets, came to the precipice of a cliff and barely caught their balance before plummeting into an abyss so deep and black that no one knows where it would have taken us. But my guess is to Hell.

The rope that held us from going over was stimulus, massive stimulus.

That stimulus was never mopped up. It’s been left out there like water on everything after the fire has been doused; and there’s more coming.

The Federal Reserve, which isn’t playing just 18 holes, but seems like it’s playing a marathon round of swinging hard and gently, but constantly swinging, is teeing up another ball with some little marking that reads QEsquared, or something like that.

Here’s my guess on what the Fed is going to do…

They’re going to stop telling us what they’re going to do. They’re going to keep us guessing about how much of the stimulus hose they’re going to unravel.

It’s an election year, you know. That means they can’t take sides. So, they’re going to do what they do under the cover of, “We’re not political; we’re going to do what we’re going to do in such a way that you idiots out there won’t know and make a judgment call on either candidate or Party.”

You see, they did that once. It became known as the Saturday night massacre. That was back in 1979, when Paul Volcker, then the Fed Chairman, on a Saturday, decided to shrink the money supply and not target interest rates as a means to kill inflation which was ravaging the economy and the country.

It worked, eventually. But it didn’t work very well for incumbent Jimmy Carter (there were a lot of other things that weren’t working for J.C. at that time), who bore the brunt of quickly rising rates and lost the election to a guy by the name of Ronald Reagan.

The point is, ever since then, the Fed has been aware of their power to move the electorate. So, they’re going to use their apolitical posture as cover to hint that they’re going to just make QE a forever program that they’re going to employ until either the markets make new highs and keep going or the economy grows at 3% to 4% per year, forever.

Oh, and China is about to do some of the same unraveling of its stimulus hoses.

What does all this stimulus have to do with the market direction? Everything.

Without it, we’d be 50% lower across the board. Yes, I am saying that the markets are 50% higher than they would be without the Fed’s pump priming. The same goes for the rest of the world.

But here’s the problem with picking the direction, or forecasting the weather. Nature finds a way. The natural order of markets can’t be messed with forever.

God help us when Mother Nature shows her wrath, and she will.

Europe is still a mess. Take away the stimulus there, and the world folds. Because China will fold, and the U.S., no longer an island, will fold too.

The problem is fiscal discipline. It’s coming. And it’s aimed at mopping up some, or a lot of that stimulus spillage that’s been floating higher and higher spending and higher and higher deficits.

So, what’s my forecast?

Either the markets will be stimulated higher, which is most likely under the present circumstances, or they will fall, once we’re spanked with the fiscal discipline paddle, or we’ll stay right about here in Goldilocks land – where it’s not too hot, not too cold.

My recommendation?

  • Straddles. Why? Because the markets will tend to fluctuate, and right now they are a riddle, wrapped in a mystery, inside an enigma. I’d be buying straddles here – long horizon, out-of-the-money straddles.
  • And I’d be selling calls on all my nice dividend-paying stocks and buying them back if they get called away and then selling a lot more calls on them.

Nothing goes up forever, especially when the hot air is rhetoric.

Be careful out there.

Shah

25 Responses to Where Would We Be Without the Fed?

  1. Dave F says:

    The Federal Reserve is a cartel. Don’t believe me? Think I’m just venting and blowing hot air? Read the book, The Creature From Jekyll Island. You’ll never look at this country the same way again.

  2. T. says:

    Thank you Shah for the “Heads Up”! Should one buy gold and silver now? That’s what I’ve been hearing. Is this a Ponzi scheme as well? Love your writing, love your life! Thanks for sharing it! You ARE the “Most Interesting Man”.

    Stay thirsty my friend!
    Thank you, Teri

  3. Concerned!!!!! says:

    I do not agree that Bernanke’s Fed is apolitical. I think he and Obama are joined at the hip, which leads me to believe that QE3 will come about the middle of October (maybe sooner) so that it has a positive impact right before and into the election in November. Those hurt badly by recent Fed policy and actions are not yet voting age, those helped can vote in November. It seems to be common sense if Obama wants to be re-elected and Bernanke wants to keep his job in January.

    • Allen Novotny says:

      I hardly doubt Bernanke wants to keep his job. I bet deep down he would love to get out of Dodge. Do you realize the pressure he is under? I think the pressure is on him to stay because if he retired now, all hell might break loose.

    • Ed says:

      Actually, Shah is not saying Bernanke is apolitical as I understand it. He says, Bernanke would only try to look like…
      There is no apolitical creature in the world of high finance, I guess.

  4. Louise Cave says:

    Like Teri, a couple of replies ago. I’d ask whether this is the time to buy precious metals. Some are saying yes, others no. One begins to wonder whether these too are manipulated by some facet of your “Matrix.”

  5. Robert in Canada says:

    I agree with Shah’s strategy to sell covered calls on dividend paying stocks he owns.

    It’s the easiest way to earn monthly income with almost no risk. If your stocks go up you get paid, and if the stocks go down you get paid.

    In Canada, there are some ETF’s that hold dividend paying blue chip stocks and do the covered call selling for you such as Horizons ETF’s: HEX, HEJ, HEF, HES, and HEE. Average annual dividend from these ETF’s is 11%, paid monthly.

    • Allen Novotny says:

      I would like to know how far out to sell the calls. Just to the next month? It sounds like a great idea and I’m really needing more income.

    • Don Moser says:

      I’d like to know more about the Horizon’s ETF’s on covered CALL SELLING being used in Canada……HEX, HEJ,HEF,HES,HEE…. (Are they available in the US ??)

  6. Dimi Chakalov says:

    Thank you very much, Shah. I only wish I knew the recipe by which you estimated that “the markets are 50% higher than they would be without the Fed’s pump priming.” It’s a staggering suicidal number. Would you please elaborate?

    Dimi

  7. Michael says:

    Shah, Let’s play “What if”. What if, let’s say, China decided to close their doors again and Nationalize everything within their Border’s and pull the plug out of the wall, cash in their US Securities and Euro-Bond securities?
    I would assume that it would erase both Europe and the US economies in one fell swoop and create “Lawyer Heaven” to sort it all out…
    Then let’s say – “What if” they changed their minds and opened the trade door again, only this time around it was on Chinese owned manufactured Consumer products and it demanded payment in Gold and Silver only? OR, in Yuan.?
    And lastly, “What if” they did this to stop the US dead in it’s tracks with their “War on Terror” (and everyone else who refuses to be bent over to satisfy their “interests” and bow to Uncle Ben’s Buck printer)?
    Do you ever think about China doing anything Extreme like the above?
    Now that the World economy is caught somewhere up in the Wild Blue Yonder without any safety nets and us little guys are seeing things we only saw in Sci-Fi Movies (Dune, Star Trek & Cuckoo’s Nest), it seems that “only the aggressor” writes the rule books. What does your Crystal Ball say for the future (other than “Duck”!)?

  8. Bruce says:

    The markets are interesting. Logic suggests that, if they’re manipulated, then they’re predictable by the manipulators. If not, then they will be less predictable. Consumer goods markets are not manipulated by consumers, though they are by retailers and other suppliers. However, some trends are still predictable, for example: prices go up, consumption goes down, and vice versa.
    So, if you’re a manipulator of the markets, what would you want to happen in order to make money before the year ends, and also if you want a change of president? If you’re the governor of the Federal Reserve, what would you want to happen, particularly if you want to keep your job which includes a target for lowering unemployment? Also, if you’re not popular with Mitt Romney, the next possible president? Finally, if you’re the president and the markets are already at a high for the term of your presidency, where do you want the markets to be by late October? All three parties are motivated by self-interest and are relatively powerful, but who is the most powerful? I am interested in a more informed view of this contest than my own, and I’m sure you can provide that.

  9. Steve Lombardi says:

    First I’m a Republican. The Fed is simply a distraction for the voters. It’s complete bs just like most of what comes out of Washington. The Bush Tax Cuts didn’t work and won’t work. How do I know this? Because many of our children, some of who have graduate degrees can’t find a job. If the BTC’s worked this would not be a jobless recovery. If the BTC’s worked where are the jobs and why did they continue to be exported?

    Second, this election is about who is going to pay the federal deficit created by the BTC’s and all the money spent on bailing out Wall Street, not Main Street. The poor don’t pay taxes so it won’t be them. That leaves the middle class and the upper class tax payers like Romney. If Romney wins it will become obvious why he’s being so ambiguous about his “plans” for the US taxpayer. The middle class will pay which is why he keeps talking about “Obamacare” (as if it were nuclear waste without a way to dispose of it). Romney’s campaign is a distraction sort of like the pea shell slight of hand game.

    [Here is the link to Romney’s campaign managers explanation of what he’s up to: http://www.youtube.com/watch?v=NeGRbfN-_08 ]

    Want to know why they are pushing for Freddie and Fannie to be dissolved and wound down? Just ask, if you know anything about real estate investing it should be obvious to you but if you want I’ll explain it.

    Steve Lombardi
    Iowa

  10. Ron says:

    “Investing”, if that is the proper word, is never easy for the little guy when the entirety of Wall St. is looking down his throat with insider information, and the financial community has become a sudivision of organized crime. Matter of fact, I wouldn’t ever call it investing.
    Of course, Wall St. isn’t investing either. When you take the risk out of speculating with insider information (the currency of Wall St.) they are shooting fish in a barrell.
    What is amazing is that the market continues to exist at all.

  11. theRedXpress says:

    I though for a second that Dimi Chakalov was going to bring what I wanted.
    Sorry to sound like a smart ass, but there is little issue with your math Shah:
    if the markets are overvalued by 50% (in your words: “Without it, we’d be 50% lower across the board”) it means that they are overvalued by 100%, not 50%.
    Sorry, in my opinion, a lack of simple arithmetic skills in this country is way too atrocious, a mental obesity of sorts.

    • vdowdle says:

      Red, Shah’s editor here. You are absolutely right. Thanks for your careful reading and for letting us know about the error.

  12. Bob says:

    The Federal Reserve got a lot of heat from the last email I sent them about that stupid QE. You are quite right that the stock markets would be 50%+ lower without the Reserve’s manipulation. But what a trade-off and what a bargain with the devil. As has been amply demonstrated, QE has done nothing to remedy the unemployment situation. QE is the road to ruin because it leads to the destruction of the currency and also the entire nation just to temporarily and artificially prop up the stock market. Not only should Bernanke not be nominated. He should fired but not replaced by like-minded Janet Yellen. If a President can be impeached, why not the Chairman of the Fed Reserve?

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