WAKE UP! 'Don't Fight the Fed' is Still Alive and Well
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There is an important question market participants are asking themselves: is "Don't Fight the Fed" dead?
In the modern world, stock investors have made fortunes living by a simple doctrine - "Don't Fight the Fed". If the Fed wants things to speed up, they speed up. If the Fed wants things to cool down, they cool down. The Fed simply had to manipulate the Fed Funds rate to achieve the end result it wanted. If the economy was too slow the Fed would simply lower the Fed funds rate, which in turn would put pressure on real interest rates thereby increasing aggregate demand. If the economy was too hot, the Fed would raise the Fed Funds rate for the opposite effect. Investors would follow the Fed’s every move to make their investment decisions.
With the federal funds rate at zero since December 2008, this tool has been essentially dead for some time. As manipulation of the Fed Funds rate was not an option, the Fed has resorted to non-conventional methods to support growth, like buying assets. The Fed’s $600 billion bond buying program, or "QE2," was a perfect example of this.
While the Fed’s bond buying tool was unconventional, the end result was the same for those that followed the “Don’t Fight the Fed” doctrine. A perfect example of this would be David Tepper’s proclamation on CNBC in September 24, 2010 that with the Fed in the market you can buy nearly everything and make money. Tepper explained the Fed had a "put" supporting the market. "You've got to love a put," Tepper said, "especially when the Fed is issuing it."
This was “Don’t Fight the Fed” trading at its finest. Tepper was making big bets on nothing other than the fact the Fed was supporting asset prices. He was proven to be right – very right. Once QE2 got underway, stocks soared higher.
August 27, 2010 was Fed Chairman Ben Bernanke’s famous QE2 speech in Jackson Hole, where he hinted at the bond-buying program. QE2 ended on June 30, 2011. If you would have bought the S&P 500 on the day of the speech you would have gained 26 percent through its end. What has happened since the Fed has been out of the market? Down 15 percent.
The above numbers show the massive impact the Fed can have when it is aggressively in the market, even using non-conventional methods.
This Friday is Jackson Hole 2011. While Bernanke will not likely announce a direct policy action, he will likely hint to what QE3 will look like. He did the same thing in 2010. Some speculation has centered around a change in the composition of Treasury securities owned by the Fed. The Fed could sell its securities that mature over the next two years and buy Treasuries in 10-to-30 year part of the curve. The Fed could also apply Treasury rate caps, set a price level or nominal GDP target, or intervene in non-government securities markets.
So even though the Fed will continue to use unconventional methods to spur growth, "Don't Fight the Fed" is not dead. Take notice or you may miss a tremendous buying opportunity in stocks.
In the modern world, stock investors have made fortunes living by a simple doctrine - "Don't Fight the Fed". If the Fed wants things to speed up, they speed up. If the Fed wants things to cool down, they cool down. The Fed simply had to manipulate the Fed Funds rate to achieve the end result it wanted. If the economy was too slow the Fed would simply lower the Fed funds rate, which in turn would put pressure on real interest rates thereby increasing aggregate demand. If the economy was too hot, the Fed would raise the Fed Funds rate for the opposite effect. Investors would follow the Fed’s every move to make their investment decisions.
With the federal funds rate at zero since December 2008, this tool has been essentially dead for some time. As manipulation of the Fed Funds rate was not an option, the Fed has resorted to non-conventional methods to support growth, like buying assets. The Fed’s $600 billion bond buying program, or "QE2," was a perfect example of this.
While the Fed’s bond buying tool was unconventional, the end result was the same for those that followed the “Don’t Fight the Fed” doctrine. A perfect example of this would be David Tepper’s proclamation on CNBC in September 24, 2010 that with the Fed in the market you can buy nearly everything and make money. Tepper explained the Fed had a "put" supporting the market. "You've got to love a put," Tepper said, "especially when the Fed is issuing it."
This was “Don’t Fight the Fed” trading at its finest. Tepper was making big bets on nothing other than the fact the Fed was supporting asset prices. He was proven to be right – very right. Once QE2 got underway, stocks soared higher.
August 27, 2010 was Fed Chairman Ben Bernanke’s famous QE2 speech in Jackson Hole, where he hinted at the bond-buying program. QE2 ended on June 30, 2011. If you would have bought the S&P 500 on the day of the speech you would have gained 26 percent through its end. What has happened since the Fed has been out of the market? Down 15 percent.
The above numbers show the massive impact the Fed can have when it is aggressively in the market, even using non-conventional methods.
This Friday is Jackson Hole 2011. While Bernanke will not likely announce a direct policy action, he will likely hint to what QE3 will look like. He did the same thing in 2010. Some speculation has centered around a change in the composition of Treasury securities owned by the Fed. The Fed could sell its securities that mature over the next two years and buy Treasuries in 10-to-30 year part of the curve. The Fed could also apply Treasury rate caps, set a price level or nominal GDP target, or intervene in non-government securities markets.
So even though the Fed will continue to use unconventional methods to spur growth, "Don't Fight the Fed" is not dead. Take notice or you may miss a tremendous buying opportunity in stocks.
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