CZAR BERNANKE’S DIKTAT: BONDS MUST BE RICH, STOCKS MUST BE CHEAP

2/26/13

As I’ve said on numerous occasions in the past, trying to discern the direction of the stock market, or any market, for that matter, is a fool’s errand.   One’s probability of being right is approximately 50%.   Years of toiling in the financial markets, as yours truly has done, might improve that probability to, say, 51%.   On the other hand, it might reduce that probability to, say, 49%.   As I told one of my fellow faculty members at a dinner at Elmhurst College last night, I’ve spent much of the last twenty years or so trading a small portion of my portfolio like a scalded dog.  The results have been no better, indeed, they’ve been worse, than the results I’ve achieved in the larger portion of my portfolio that is emotionlessly invested in a balanced portfolio of index and index like products.  The point is that, despite the millions, and probably billions, invested by the financial sector in trying to call markets, doing so is basically a crap shoot.   However, since those who populate the financial world, and especially the financial media, ceaselessly are flapping their jaws telling us which way stocks will go, doing so is great sport, and the opinions of these estimables are no better than mine, or yours, I will indulge in this rather pointless pursuit, not so much for the sake of direction as for illumination of a larger point.

Over the last few weeks, or months, really, pundit after pundit has been telling us that stocks are cheap because, with the 10 year treasury at 1.87% and corporate spreads tight, or at least not wide, where else is there to put one’s money?   In other words, stocks are cheap relative to bonds so we have to buy stocks.   But, with a Fed engineered bubble to end all bubbles in the bond market, EVERYTHING is cheap relative to bonds.   That they are cheap relative to a hideously inflated bond market is no reason to buy stocks.  

There are, of course, other reasons to buy stocks, but all those reasons have a counter.  Yes, profits are quite good…right now.   But it’s hard to see how they will stay good if the domestic economy remains moribund, China and Europe are having trouble, and consumers are getting hit with the double whammy of high gasoline prices and a big increase in the payroll tax in an environment still characterized by too much debt.   Then we have the potential political time bombs out of Europe and Washington.   How these balance out, no one knows.   But the only reason for buying stocks that is more or less unanimously agreed to is their cheapness relative to bonds.  And buying a house was cheaper than renting in 2007, or so it seemed.  The analogy is not perfect, but you get the point.

What is genuinely scary about the “stocks are cheap relative to bonds,” and the real point of this post, is not whether that argument is correct.  What’s really scary is that stocks have been made cheap relative to bonds as part of a conscious, deliberate, and relentless Fed policy to make stocks cheap relative to bonds.   The Fed has transcended its customary role as custodian of the nation’s monetary supply to become a kind of economic czar, determining what levels are appropriate for various asset classes, where capital should be directed, and what segments of the economy are worthy of the succor loose money can provide.   That a quasi-government agency has vested itself with so much power, with little or no resistance from the governing class, which is always eager to cast off responsibility, is what is truly frightening, and not only for the stock market, but for our financial system, our economy, and the very notion of a free market and a free society.