Don’t-Fight-The-Fed Confidence Turns To Worry That Fed Might Take Us Over A Cliff

By Cali Money Man, Wolf Street Exclusive:

It’s a long litany of omens.

Barely 2% GDP growth, with much of that going to profits. Low levels of business investment. Corporations leveraging up to buy back their stock and pay dividends. Slow growth in household income, almost all of which goes to the rich. Low levels of public investment, with rapid growth of public sector liabilities, and an added threat: many state & local governments will experience financial stress in next 5-10 years as their pension obligations come due.

Inflation is slowing despite Fed’s QE3 at $1 trillion per year. The Fed’s balance sheet and money supply are ballooning, but there are no precedents in peacetime when these policies were successful. And asset prices are rising.

I have farmers as clients who are minting money as they leverage up to buy rapidly appreciating farmland. The Fed is already worrying about the banks that lend to them. NYSE margin debt is at a record high. Earnings are growing faster than revenue, while earnings quality drops. There are market leaders with 3-digit P/Es – or no earnings at all, or with huge losses.

The hottest IPOs have no earnings. On its first day of trading money-losing Twitter’s price/sales ratio might exceed Amazon’s fabulous price/sales ratio of 16. That was during the peak of the dotcom bubble in 1999. A year later, Amazon’s stock had crashed, and the price/sales ratio settled at 2.

We are told by economists that this experiment is under control, with no possibility of a bad outcome. But each year their forecasts of economic liftoff, which have been used to rationalize the high stock prices, have proven false. I would prefer them to worry.

When I suggested to an experienced tech entrepreneur that Twitter might be overvalued at $11.1 billion, he said it was likely going to hit $25 billion before declining. Today, Twitter’s IPO price has been raised to give it a market capitalization of over $15 billion.

Slowly people’s Don’t-fight-the-Fed confidence changes to worry that the Fed might be taking us over a cliff. As in articles such as this in The Telegraph:  “The Fed is locked in a QE prison of its own making.” “US policymakers are caught in a trap – a seemingly inescapable dilemma that stems directly from the massive scale of QE,” writes Liam Halligan.

How can anyone look at this without concern? Many portfolio managers are riding the wave but are prepared to dump their investments at the first alarm – which is itself disturbing. Who is going to buy when they all start dumping their assets at the same time?

So what is the refuge? Ten-year Treasuries? Emerging market stocks and bonds? None of these look attractive, let alone safe. Cash is career suicide.

It’s like the scene in Bored of the Rings:

He remembered Bromosel’s ill-omened dream and noticed for the first time that there was a large blotch of lamb’s blood on the warrior’s forehead, a large chalk “X” on his back, and a black spot the size of a doubloon on his cheek. A huge and rather menacing vulture was sitting on his left shoulder, picking its teeth and singing an inane song about a grackle.

Other than that, no worries. Or as one of our national heroes in the US says: “What, me worry?” Just like 1999 and early 2007. By Cali Money Man, Wolf Street Exclusive.


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