The Real Cost of the Fed's 'Easy Money' Policies
The Federal Reserve attempts the impossible... The real cost of the Fed's 'easy money' policies... 'Soft landing'? Don't bet on it... The buyback boom continues... Dan Ferris' brand-new, No. 1 recommendation...
Folks in the mainstream financial media are enamored with the idea of a 'soft landing'...
This is the idea that the Federal Reserve can pull its economic "levers" just so – gradually raising interest rates and slowly unwinding its quantitative easing program – and withdraw its unprecedented stimulus efforts without triggering a recession.
Unfortunately, history suggests this is unlikely.
According to the official record, the Fed has pulled off this feat just once in its history... Then-Fed Chairman Alan Greenspan doubled rates in 1994 without causing a recession (though you could argue the burgeoning tech boom may have had something to do with that).
Every other "tightening" cycle has been followed predictably by an economic slowdown.
It's not hard to see why...
When the Fed cuts rates or otherwise eases monetary policy, it isn't simply "stimulating" the economy. It's also distorting the most important source of information in the economy. As Porter explained in the April 28 Digest...
Money conveys critical information to entrepreneurs and consumers via prices. We learn about shortages from rising prices. We learn about gluts from falling prices. And every day, hundreds of millions of consumers, producers, investors, and bankers are using prices to make judgments about what they should do next with their money.
Trouble is, when the monetary system is being manipulated – when it's being inflated and controlled by the world's central banks – those prices we are all relying on become warped. As a result, more and more "noise" enters the channel – false information... prices that aren't real... prices that don't accurately reflect supply and demand... or risk...
In other words, when the price of money is artificially lowered, bad things often happen...
Investors and entrepreneurs are incentivized to take more risk than they might otherwise
So it follows that when the Fed eventually raises rates or tightens monetary policy, much of this activity no longer makes sense. The false signal is removed, and the economy slows as economic reality sets in and bad debts are wiped out.
This perpetual teeter-totter is known as the 'business cycle'...
And it's largely the Fed's doing.
To be clear, that doesn't mean we wouldn't see booms and busts without the Fed. So long as the economy is made up of humans and their emotions, periodic excesses are unavoidable. But without broad manipulation of money and interest rates, these would be far less severe.
This is bad enough. However, the Federal Reserve has managed to make it even worse...
You see, for the past several decades, the Fed has refused to let even this process fully play out...
Instead, it has responded to every downturn – or perceived
The Fed's response to the emerging markets crises of the 1990s helped fuel the dot-com boom and bust. Its response to that recession led to the housing bubble and the global financial crisis that followed. And its response to that crisis – in concert with central banks around the world – has now created the biggest and most pervasive bubble the world has ever seen.
So no... we don't expect to see a soft landing this time around, either.
What comes next will be no ordinary recession or bear market.
Of course, inevitable doesn't mean imminent...
As regular Digest readers know, we believe this boom could continue
In fact, our colleague Steve Sjuggerud – who has "called" this bull market better than anyone we know – believes the "
Steve follows a number of long-term indicators which have warned of previous downturns many months in advance. And none of them are signaling danger at this time.
Today, we can add another data point in favor of the bulls...
One of the biggest drivers of higher stock prices over the past few years remains intact.
Back in December, Congress voted to cut the corporate tax rate from 35% to 21%. As we explained in the December 21 Digest, we expected this lower tax rate, combined with the potential for a "repatriation holiday," could lead to a surge in corporate share repurchases (or "stock buybacks"). And it looks like we're already starting to see that play out...
According to investment-research firm TrimTabs, U.S. companies have repurchased nearly $5 billion worth of shares per day through the first three months of the year. That's double the pace from the first three months of 2017.
Bloomberg reports they've bought more than $153 billion in just the last month alone. That's more than any single month in history.
All told, investment bank JPMorgan Chase (JPM) expects a record $800 billion-plus in buybacks in 2018, up from $530 billion last year.
The numbers could be a major boon for investors this year...
After all, a falling share count means that each remaining share gets a bigger piece of the earnings "pie." And rising earnings-per-share – one of Wall Street's favorite metrics – could continue to drive the market higher.
But while this could be bullish for the market in the near term, it's important to remember that share buybacks are a double-edged sword. They're only beneficial to shareholders over the long-term when a company buys back shares at a reasonable valuation.
And as Extreme Value editor Dan Ferris reminded us in a private e-mail this week, this is relatively uncommon...
Making good use of share buybacks requires a company to hold on to its cash when its stock is expensive. That's harder than it sounds. Think about how bullish investors were in 2007, right before the market peaked.
Then, when the market crashes, companies have to have the fortitude to go out and buy their own shares, hopefully at a discount to what the business is actually worth.
Think about how bearish investors were in early 2009. Corporate executives are just like everybody else. They bought tons of shares at the top in 2007 and very little at the bottom in 2009.
People are emotional, whether they're individuals managing a 401(k) or corporate executives making billion-dollar share buybacks.
Worse, many companies are compounding this mistake today...
They're paying out more to shareholders in the form of dividends and buybacks than they're actually earning from their operations. And they're using debt to make up the difference.
Again, the reason isn't hard to understand. Thanks to central bank manipulation, debt is relatively cheap today. Management teams can "juice" their numbers by using buybacks to convert this debt into higher earnings per share.
And it surely doesn't help that many executives – whose compensation is often tied to these metrics – are actively incentivized to risk the long-term health of their companies in exchange for short-term boosts in share prices.
Dan agrees...
With many stocks near all-time highs, Dan is wary of companies spending billions of dollars buying back shares today. As he explained...
The bottom line is buybacks are an investment, an allocation of capital. And the returns you get depend on the price you pay. So if you pay a horrendously high price, you're going to get a horrendously low return.
There's no magic to buybacks. They can't turn a mediocre business into a great one. But they can turn a great one into a mediocre investment by making too many repurchases at too high a price.
This is especially relevant today...
At this stage in the historic bull market, Dan says it's more important than ever to invest in companies with proven management teams that use buybacks wisely...
And he says he recently found one of the best he has ever seen.
Not only does
It gushes free cash flow... boasts thick margins... has hundreds of millions of dollars' worth of cash with zero debt... and generates a consistently high return on equity.
It's no wonder Dan is calling this company his "brand-new, No. 1 recommendation." In fact, he says if he could put every penny of his life savings into one stock, this would be it. Learn more about this opportunity right here.
New 52-week highs (as of 3/12/18): Apple (AAPL), Amazon (AMZN), CBRE Group (CBG), Global X China Consumer Fund (CHIQ), Cisco (CSCO),
In the today's mailbag, more on Porter's "best recommendation of all time"... and some mixed feedback about investing in legal marijuana. What's on your mind? Let us know at feedback@stansberryresearch.com.
"Porter, I have now been an Alliance member for about 8-9 months and I just can't tell you enough how much I have learned and benefited from all the teachings and recommendations. [Friday's] Digest is just another example. Keep up your great work as well as all the other information you all provide." – Paid-up Stansberry Alliance member Mark Uremovich
"Great stuff – well-written, too. Bravo." – Paid-up subscriber Emily S.
"Dear Sirs: I am very disappointed that you continue to promote investment in the drug trade. Marijuana is simply an entry level drug that's helping destroy our nation's moral fabric. It's being legalized by the 'swamp' whose members see easy tax revenue and huge kickbacks. Promoting this trade as any sort of investment make me question everything you produce. Any more
"Team, it is sad to hear that people cancel their subscriptions simply when you mention marijuana. They are idiots. I would like to know how to invest in an intelligent manner in this new industry. The people who got rich in the gold boom in the 1800's were selling picks and shovels. Why don't we invest in the new companies that will sell the 'picks and shovels' to this new boom trade? P.S. Keep up the good work. It is hard to find honest people. And I think you are honest people." – Paid-up subscriber Brian F. Madison
Brill
Regards,
Justin Brill
Baltimore, Maryland
March 13, 2018