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The Fed: A Bull in Search of a China Shop

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Thursday, 24 January 2019 04:56 PM Current | Bio | Archive

Twenty years later, the movie Office Space has stood the test of time. It still holds up as the best portrayal of what a typical American corporate workplace is really like.

That includes everything from a muddled org chart to annoying coworkers, to adequately defining an employee’s work role.

In one particular scene, a pair of consultants ask an employee this key question:

“What would you say you do here?”

The employee’s increasingly belligerent response while claiming to be a people person is more than another satirical jab at the workplace. It’s the epitome of being on the defensive and unable to bend to the breeze and react to potential changes in the workplace.

But it’s a good question any employee should know the answer to. While it’s still early in the new year, it may be a good idea to look over the work you’ve done, where it’s varied from the work you were brought on to do, and be prepared to back that up with some numbers and data for your higher ups.

(While you’re at it, throw it on your resume too. After all, looking at today’s job numbers, there’s nothing wrong with looking for greener pastures.)

But I’m not just here to talk personal development, even if it is one of the best investments you can make in your life.

Right now, “What would you say you do here?” is the same question that investors are asking the Federal Reserve.

America’s central bank seems to be at odds with just about everyone right now.

And, in fairness, on paper, they’re asked to do a lot. The bank was originally created by Congress to “stabilize the banking system,” following the Panic of 1907 and a government bailout by private citizen J.P. Morgan.

For the Fed, creating that stability has mostly meant fighting deflation. It’s easier to inflate an economy than deal with the perception of pain that goes with deflation. That’s why inflation became a long-term phenomenon after the creation of the Fed. Before the Fed, we had periods of both inflation and deflation, and price levels would generally average out over time.

Following World War II, the Fed was tasked with directing the economy in a way that would lead towards full employment, even if that meant creating inflation.

Never mind that the Fed’s main tools involve setting interest rates, rather than letting the market determine what a borrower and lender should agree on in terms of the cost of capital. This system is more at home with a Soviet politburo than with our free-enterprise history.

That’s just part of the problem.

Since the one-day, 22-percent decline in the stock market in 1987, the Fed has also been tasked somewhat officially with keeping stock markets from plunging as well. The record there hasn’t been great, with the fueling and bursting of the tech and housing bubbles in 2000 and 2008 respectively.

Somehow, a mere decline in the stock market has become synonymous with deflation. And while I’d argue that the extreme debt creation leading up to the housing bubble did lead to a major fight in deflation in the 2008-2011 era, we’re well past that.

Today, the Fed is now taking flack for either raising interest rates too quickly or not having raised them years earlier.

While I agree that staying at zero percent for so long was troublesome, it was also an appropriate response given all the “mission creep” that Congress has outsourced to them over the decades. And I’d also argue that, given today’s inflation rates, even a 2.5 percent funds rate is still pretty close to historic lows and free money.

The bigger issue is one of liquidity. The Fed is also shrinking its balance sheet at the same time it raises interest rates. That’s the real problem, as it’s the equivalent of hitting two sets of brakes at once. While the Fed stepped back from more rate hikes as 2018 came to a tumultuous end, shrinking its balance sheet by selling off assets it bought during a crisis requires a light hand.

A central bank can do many things, but typically acting with a light hand isn’t one of them.

That spells more volatility for markets.

Expect some big down days—and some big up ones as well. And expect some relative calm if the Fed stops hiking rates. But beware—it can take up to 18 months for a rate hike to be completely felt through the entire economy. That’s partly why some folks have said the bank has moved too far, too fast with its gradual changes. They may not have been gradual enough.

The good news is, those big swings in the market are where opportunities are created. Periodic 10-15 percent drops are normal, healthy, and give us some good entry prices on great companies to buy.

The worst case scenario, however, is another credit crisis, similar to the one that gripped markets in 2008. Lending may dry up, as banks and other institutions decline to lend capital as freely—even though they can now do so at higher rates. If you’re considering getting a loan for anything, strike while the iron is hot. It may cool surprisingly quickly.

History has shown that there’s little the Fed can really do to help the economy beyond some short-term rallies on favorable speeches by its members. But it can really do a lot to fuel and burst bubbles.

It’s a bull in search of a China shop, and as long as investors can wait to pick up the pieces at a huge discount, they don’t have to proverbially “fight the Fed.” Instead, they can profit from these moves.

Keep cautious, but keep an eye out for plenty of trading opportunities this year. Focus on companies that aren’t dependent on short-term lending conditions. They’ll hit the skids first if a worst (or simply worse) case scenario starts to unfold.

And in this kind of market, taking advantage of short-term rallies to raise some more cash and increase your holding there isn’t the worst idea. Cash ended up doing better than the market as a whole last year, and being able to buy shares of great companies on the cheap requires a bankroll.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

© 2019 Newsmax Finance. All rights reserved.

   
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The Fed is a bull in search of a China shop, and as long as investors can wait to pick up the pieces at a huge discount, they don’t have to proverbially “fight the Fed.” Instead, they can profit from these moves.
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Thursday, 24 January 2019 04:56 PM
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