By E.B. Tucker, editor, Strategic Investor

E.B. Tucker

I’m betting the Federal Reserve’s next move is buying $1 trillion worth of stocks in the open market.

Ten years ago, Fed governors rarely got airtime on financial media. Twenty years ago, we only heard from the chairman occasionally. These days, the Fed is all we hear about.

Most average investors still don’t know that there are 12 Fed banks. Each has a president. However, the New York Fed is the only one that matters. It holds all the power.

It’s the New York Fed that bought trillions of dollars’ worth of U.S. Treasurys after the 2008 crisis.

Chart

The idea behind gobbling up Treasurys was to stabilize the U.S. government’s funding market. Federal Reserve primary dealer banks bought up Treasurys during government auctions. They then flipped them to the Fed days later.

Normally, government revenues fall during a recession. With this scheme, congressional funding kept growing right through the downturn. Government rarely shrinks.

Here’s the problem… Like a dope fiend who swears he’ll ease himself off the hard stuff, the Fed and its enablers in Congress said they’d return the system to normal after it stabilized. The truth is, they will never turn the money system back over to the markets.

The Playbook

Create a policy with unintended consequences. Down the road, that new policy causes another crisis. Policy, unintended consequences, crisis… Repeat until the economic system explodes.

Crisis creating and crisis solving is profitable work. Sure, the brainiacs at the Fed aren’t getting rich. They’re humble servants, of course.

The plan at the outset was to buy just enough Treasurys and mortgage-backed securities to stabilize the system. To get things back to normal.

The slightest tinge of withdrawal earlier this year was too much to bear. In the previous chart, you can see the Fed shrunk its colossal Treasury holdings by just a few hundred billion, or about 16%.

Last month, the Fed actually increased its debt buying for the first time since 2017. We didn’t see anything in the news about this. We also think it’s the initial step in QE4 (quantitative easing)… which is the Fed’s fancy term for printing more money.

Chart

Bond buying won’t be enough this time. Government revenues are at all-time highs. In fact, with 26% of the world’s sovereign debt trading with negative rates, demand for Treasurys doesn’t need help.

The last time the Fed also bought mortgage-backed securities, the intention was to stabilize the housing market. With mortgage rates near all-time lows at 3.58%, lower borrowing rates won’t help things much today either.

That’s why I think the Fed will buy stocks at the next sign of trouble… which could be soon.

Looking to the Future

Pretend today is September 4, 2021… two years into the future.

The Fed just wrapped up a program in which it bought $1 trillion worth of U.S. stocks.

In late 2019, the weight of crippling debts and a shrinking economy cracked the stock market. Investors sold at any price to get what they could out of stocks.

The Fed stepped in to “stabilize” the stock market… to protect retirement accounts. To allegedly ensure that hard-working Americans could sell their 401(k) assets as needed without fear of losing a lifetime of effort.

It could call this program RAPSAF-1. That could stand for Retiring Americans Profit Security and Freedom. The “1” at the end designates its first foray into buying stocks to stabilize the markets. The financial press would trip over itself predicting when Round 2 would begin.

You might think this sounds crazy. It’s not crazy at all.

In July, Reuters quoted Larry Fink, CEO of BlackRock (the world’s largest asset manager), in a story in which he called on the European Central Bank to buy stocks. He said, “I’m a big believer that Europe needs to find ways to have the Europeans focusing on investing for the long term through equities.”

You might say, “That’s Europe, things are different.” But it’s important to remember how these radical policies become normal. Heavy hitters like Fink, who stand to make billions if the Fed buys stocks, begin talking about central banks buying stocks. Others join in. Before long, it doesn’t seem so radical.

The Swiss National Bank buys stocks. It owns over $90 billion worth of U.S. stocks.

The Bank of Japan buys stocks. It owns a full 4.7% of its stock market already. In the same Reuters article, Fink implies it should consider buying more, since many Japanese sit on extra cash in savings accounts. That means Fink wants you to stuff your savings in the stock market, preferably in one of his funds.

If the U.S. matched Japan’s central bank in buying nearly 5% of the stock market, that means about $1.5 trillion of Fed funny money injected into the market.

Remember, $2 trillion worth of Treasury buying sent U.S. interest rates to all-time lows. I don’t see why $1.5 trillion worth of stock buying couldn’t send price-to-earnings (P/E) ratios to all-time highs. (The P/E ratio measures how much investors are paying for each dollar of current profits.)

Today, the S&P 500 trades with a P/E of 19. Don’t get me wrong: With a slowing economy and mounting debt problems, that’s no bargain. That is, of course, if you’re looking to the past for guidance.

With a whale buying $1.5 trillion worth of stocks, P/E ratios could surge to 30. That’s 58% higher than today.

With savings accounts yielding 0%, Treasurys yielding little more than 0%, and real estate yielding in some cases less than the cost to maintain it… stocks could easily trade for 30-times earnings.

Remember, the Fed’s radical money experiments usually show up as a crisis response. If it ends up buying $1.5 trillion worth of stocks, the market might take a beating first.

That means a big drop in stocks might justify the Fed’s next radical move, which is becoming the world’s largest stock buyer. If so, many average investors will be scared out of stocks before the whale starts buying. Keep that in mind.

In my Strategic Investor newsletter, we talk about having a mix of high-quality, resilient stocks and cash. That’s a way to stay in the market, if stocks run higher, and still have enough cash set aside to take advantage of a market shock.

Regards,

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E.B. Tucker
Editor, Strategic Investor