Wall Street refers to it as the “Bernanke Put.” Given the Fed chairman’s dour testimony on Capitol Hill yesterday, this concept — embraced enthusiastically by the Crowd on Wall Street — is worth discussing.
The Bernanke Put refers to the Street’s belief the Federal Reserve will not let markets fall too hard and fail, that Federal reserve policies are a put on the market itself. This is the mega-version of “too big to fail” — the market is too important and has too big a role in the world financial system and the economy for it to be allowed to crash again. The Street assumes, believes, forecasts and prays that Uncle Ben — a closer cousin to Uncle Sam than at any time in history — will step in as needed if markets fail.
And, if the economy fails, which it is doing at an accelerating rate.
There is no evidence that the liquidity created by the Fed post-Lehman Bros. has helped the economy directly. The evidence is to the contrary. This liquidity is only circulating among people buying and selling assets, the Crowd on Wall Street; it is not circulating in the real-world economy. Bernanke pretty much said this yesterday when a Senate panel, drawing their salary and doing little else, asked what he could to bolster a flailing economy. Chuck Schumer of New York told Uncle Ben to “go do your job.” Bernanke was too smart to say, “I will if you will,” but his smile said everything. If more easing measures from the Federal Reserve mean little to the economy, why is the Crowd so wanting more liquidity?
There are two reasons. Some of it may support and increase trading activity and, more importantly, the announcement and perception of more liquidity is a trading event and catalyst for the market in and of itself. A home run by a star or popular player for a team losing eight to nothing still elicits cheers and even some hope, even though it is meaningless. Ditto for more easing from the Fed. But those cheers are tradable, and enough noise and the crowd enjoys the game again. Ditto for the market – enough bullish traders jump on more easing and the market will go up, perhaps a lot.
The date to watch is Aug. 19, when Uncle Ben leaves Uncle Sam for a few days and goes to Jackson Hole, fondly remembered as the place he announced a big round of quantitative easing that started a very serious bull rally. The market is building momentum towards this date, creating a binary event – no news, no more easing or very little easing will hit the market hard, modest easing will keep the market going sideways and serious easing will push the markets higher.
Serious easing or no easing?
This is not exactly fresh analysis. The real question is what constitutes “serious easing” or “no easing,” the potential drivers of the market. My thoughts:
• No easing would mean nothing new, a program the Fed states is the last round of easing it will do for the foreseeable future or fiddling around with its balance sheet on the edges, perhaps a brief extension of Operation Twist.
• Serious easing would mean a half-trillion dollars or more expansion of the Fed balance sheet. If this happens, it would probably be to buy mortgage-backed securities – with the kicker that the promise not to raise interest rates through 2014 would be extended into 2015. Since I believe the Fed has done too little with its balance sheet and we are suffering through historically high real interest rates, we stand more of a chance of serious easing than no easing at all.
I gave a seminar in Raleigh last weekend and got the typical questions about the Fed “printing money” and ruining the world. The Fed balance sheet, relative to the amount of capital available in primary credit markets, shrank for almost 40 years before the Lehman-bankruptcy-induced crash. We are suffering from massive asset deflation, banks here are undercapitalized, banks in Europe are astonishingly undercapitalized, led by those paragons of fiscal virtue, the Germans, whose state banks are a joke and leveraged, some believe (including me) up to 50 to one.
I also believe Bernanke is coming around to this point of view and seeing his actions through the prism stuck in the early parts of a massive credit contraction and deflationary cycle. If that is the case, then Uncle Ben may not speak about robust new programs at Jackson Hole but he will keep a gentle and firm foot on the liquidity gas pedal, putting a floor under the market.
What does that means for investors? Many traders read old, out-of-date textbooks – they are the only ones available, actually – and more Fed action means ungrounded fears of currency devaluation and inflation. Trade that crowd – trade the hard-asset bucket, gold (the GLD), silver (the SLV), and for a while, before more production comes online, oil (the USO). If you buy these ETFs, sell calls against them and generate income every week or month as you need it.