The Fed has It Wrong with the Taper

This is certainly not new news for my readers, but I continue to be in the very lonely camp that the Fed is misguided in tapering the $85 billion in monthly bond purchases and they should totally hold off raising interest rates until our economy gets to the other side of the next recession.

As you know, we have been in the slow growth and no inflation camp for years, a theme we still have a high degree of confidence in, hence our very large position in long-term treasuries this year in our Global Asset Allocation program.

Yields on the 10 year note have hit our downside target of 2.5% and even stretched to almost 2.3% before reversing. In the short-term, yields will probably rise and then at least revisit the 2.3% area next month or later.

Below is the most controversial of the three segments I did with the good folks at Yahoo Finance last week. Enjoy!

Fed Has It WRONG

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No Foot in Mouth for Yellen Today

The Fed concludes their two day meeting today with the market expecting no increase in interest rates and another $10 billion tapered from their QE program. That would leave the Fed to continue purchasing treasury bonds and mortgage backed securities to the tune of $45 billion per month.

After Janet Yellen’s rookie gaffe six weeks ago during the press conference, the chair is lucky that there won’t be another press conference today. Rather, the Fed will release a statement with no opportunity for Ms. Yellen to be cornered again. All eyes will be acutely parsing every word in the statement for hints of future rate hike and acceleration in the taper.

It’s no secret that I am 100% against ANY taper. I am probably the ONLY person on earth who feels that way which given my contrarian nature, makes me confident in my view. It’s a good topic for a full article. You can watch my recent Yahoo Finance Breakout segment, Fear the Taper, for more.

The stock market model for today is lots of choppy action, plus or minus 0.50%, and then a rally. History shows there is a 70+% chance of closing higher today.

Do NOT Taper

As difficult as it was at the time, quantitative easing (money printing) has now become an acceptable weapon in the Fed’s arsenal. Throughout my life, I was always taught, wrongly so, that printing money always leads to inflation and sometimes hyperinflation. And that all we needed to do was look at the Weimar Republic or Argentina or most recently Zimbabwe for examples of a currency gone rogue.

When the Fed cut rates to essentially zero, critics and Doomsdayers came out of the woodwork crying that Bernanke was “out of ammunition” and that “the Fed was now impotent”. The initial decision to print money must have been one of the most difficult debates that any Fed has ever faced. I imagine that the FOMC meetings were only a small part of the spirited discussions that went on during late 2008. But in the end, after rates are zero, Bernanke & Co. used QE as a way to effectively continue cutting rates until the economy and markets began to stabilize and turn.

Having been in the deflation camp since 2007 and remain there today, I have always said that printing money would not even slightly increase the risk of problematic inflation. I can’t tell you how many times I did interviews on CNBC, Fox Business and Yahoo Finance where I defended this very minority view against the masses. And when I boldly declared after QE I that the Fed’s balance sheet would eventually approach $5 TRILLION, I was literally laughed at and dismissed as a nut job (well, part of that may be true!). Furthermore, as longtime readers know, I turned very bullish on the dollar, long-term, in early 2008 and have stayed that way ever since. It was such an easy argument to say that all this money printing would devalue the greenback, but the truth of the matter is that the U.S. dollar bottomed in March 2008 and with almost $5 trillion being printed since, it has never gone lower than that level. Once again, the masses were wrong.

Once a Fed, or anyone else in my opinion, does something that is so distasteful, like having to print money, the hardest part is over, the first act. It makes the next and the next and the next much easier. After QE I ended and people argued against any more printing, it wasn’t a stretch to believe that a whole lot more was on the way. In fact, I would and have argued that once a Fed begins the process, they absolutely MUST see it through to the end, much longer than anyone imagines.

For the fifth time since Bernanke first hinted at tapering in May, the Fed will have the opportunity to begin the scaling back of asset purchases today. I firmly believe they should NOT taper! While the employment picture is certainly much improved, it is far from “escape velocity” with the participation rate at extremely low levels. After a “normal” recession, GDP growth should be double where it is today and remains frustratingly below trend levels. And that says nothing about the inflation rate and money velocity which indicate we should be worried more about deflation than any kind of problematic inflation. No sir. The Fed should NOT taper now or any time in the near future.

Let’s not repeat the mistakes made by FDR in the late 1930s when the government caused part II of the Great Depression by pulling stimulus and raising taxes. And let’s not let the Japanese debacle of starting and stopping and starting and stopping QE become our pattern. From my usual minority seat, my thesis is that the Fed should not begin to taper until we get to the other side of the next recession. Said another way, the Fed shouldn’t consider scaling back their asset purchase program until at least 2015 or later. Doing so now or early next year will jeopardize the flailing recovery and have a very negative impact on the financial markets over the intermediate-term.

I have heard plenty of people say that “tapering isn’t tightening”. I vehemently disagree. If a crack addict smokes 12 times a day and then is cut to 10 and then 8 and then 6 times a day,  his body will certainly feel the reduction. As I have said many times before, our markets have become addicted to QE and are not healthy enough on their own to survive without it.

Fed Should NOT Taper!

Paul Schatz, president of Heritage Capital, typically lets it all hang out when expressing his views on markets, economics and sometimes even politics.

An active asset allocator and adviser with 25 years’ experience, Mr. Schatz is on board with the Federal Reserve‘s quantitative-easing policy and would even like to see it extended beyond early next year, when the Fed is expected to start tapering its $85 billion in monthly bond purchases.

InvestmentNews: Do you think it’s time for the Fed to start reducing the five-year QE program?

Mr. Schatz: From my perspective, the answer is no. If you believed in quantitative easing to begin with, you can’t stop now. The results of stopping now will be disastrous. The big problem is QE was created because rates were already at zero, so it is effectively a way to get negative rates. I don’t believe the economy can stand on its own right now without quantitative easing.

InvestmentNews: What do you want to see before you’ll support tapering of the QE program?

Mr. Schatz: Ever since 2008, my thought has been that this is a typical post-crisis recovery. You don’t cut back on QE until we get through the next recession. There’s always another recession coming, that’s the business cycle. If we had quit QE after the first round, we probably would have had another recession and then we probably would have been done with it, but it would have been painful.

InvestmentNews: What is the biggest challenge facing the U.S. economy?

Mr. Schatz: I don’t think there’s a single biggest challenge. We’re living through this typical post-recession recovery. Companies are beating on [the] bottom line, but not on [the] top line. But probably the biggest challenge is the employment markets, but they are functioning exactly as they should in a post-recession recovery. We are going according to the script, but people don’t have the patience to live through it.

InvestmentNews: Where do you see the greatest areas of opportunity?

Mr. Schatz: That’s the toughest part. You have a triple-digit gain in this bull market, but the bull market is old. I think we’re approaching crucial point toward either a melt-up followed by a correction of 50%, or we peak during the first quarter of next year and have a garden-variety pullback of 20% or 30%.

The opportunity is to be really, really mindful of the portfolio. Presumably, most people have made a lot of money in last five years. People are feeling really good and they’re into passive strategies. I think this is the most opportune time to employ active strategies in a portfolio. Right now, we’re in the danger zone where risk is increasing every day, and you need to lay some protection on the portfolio.

InvestmentNews: Do you think the botched Obamacare rollout will have any impact on the markets?

Mr. Schatz: I think it has zero impact. Except for making incredible media fodder, I don’t think the rollout or fixes is having any impact on markets right now. I do think it will have a permanent and detrimental impact on the economy longer-term.

Jeff Benjamin covers investment strategies in his award-winning column, Investment Insights, and also dives deep into the minds of leading portfolio managers in his regular column, Portfolio Manager Perspectives.

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