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Blowing up a popped balloon


Recently my wife logged into our Mint account, and had a mild freak-out when she noticed how little money was in our money market account.  “Um, Catt – Where’d our money go?”

After a short discussion about the Fed, interest rates, bubbles, and the cycle of bubbles that America is currently destined for, during which Mrs. Catt mostly just rolled her eyes and patiently waited to find out where the money went, I said I had invested it into dividend paying utility stocks (specifically PGN and DUK).  Satisfied that we weren’t one paycheck away for being cash-broke, she went back to trying to find a comfortable position for her 8-month pregnant belly, and grunting.  (Mostly grunting – To be fair, when she’s not 8 months pregnant, she rarely grunts.)

The Fed is killing savers.  In a world where 5 year treasuries are yielding just over 1%, there is little that banks can do to compensate savers.  The best money market accounts are struggling to pay 1%, and even long term (5 year) CDs are paying a paltry 2.25%.  At that rate, you’ll double your money in about 31 years.  Quantitative Easing 2 (QE2) will just make things worse.

Just as it did back the early 2000’s, after the previous recession, the Fed is pursuing easy money policies in an attempt to inflate asset values.  The previous effort, while mild in comparison to today’s programs, contributed not only to another stock bubble, but also to a massive housing bubble.  When both of those burst, the economy entered the worst recession most Americans alive have ever known.  Not having learned its lesson, the Fed is once again trying to re-inflate the popped balloon in an effort to stave off deflation.

So, by buying long term treasuries, the Fed is hoping to make borrowing cheap, raise asset prices, encourage business investment, and avoid deflation.  This intervention will have a huge impact on investors.  Investors should move aggressively to take advantage of the opportunities that present themselves.

1) Refinance.  Mortgage rates haven’t been this low since the early 1950’s, and probably won’t be again.  While debt is awful during deflation, it’s great to have during inflation, since the real (inflation-adjusted) value of debt will decline.

2) Invest outside of America.  Foreign stocks, especially emerging markets, have had a huge run-up over the past year, but still trade at a discounted P/E compared to U.S. stocks.  And economic growth is much stronger in China, India, Brazil, and Australia than it is here.

3) Be prepared to move away from government bonds.  Once the easing programs subside, and the economy starts a stronger recovery, inflation will take hold, yields will rise, and bond prices will drop.  The greatest bond bull market in decades will end with its own pop.

4) Large, stable dividend paying companies are worth a look for getting somewhat better returns than a money market, while still providing a fair amount of liquidity (due to large trading volume) without much risk of losing your capital (PGN currently has a beta of .38).

But overall, don’t fear government interventions, and don’t worry about getting on your ideological horse.  Every time the Fed acts, there will be winners and losers, and by taking the right steps, you can be one of the winners.

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