Investment Contrarians

Investments to Avoid as “Fed-Fueled” Bubble Continues to Grow

By for Investment Contrarians |

Investments to Avoid as “Fed-Fueled” BubbleIf you’ve read my articles before, you will know that I have voiced my concern many times in the past regarding the Federal Reserve and its current aggressive monetary policy stance.

In my article “Dangerous Investments Fueled by the Federal Reserve,” I noted that it is extremely dangerous to be invested in bonds, because the current monetary policy plan is artificially inflating many parts of the economy and the financial sector.

I am not alone. Just the other day, David Stockman, former budget director for President Reagan, published an essay in which he also voiced his concern that the American economy is a bubble being pushed higher by the Federal Reserve. (Source: Rubin, R., “Stockman warns of crash of Fed-fueled bubble economy,” Bloomberg Businessweek, April 1, 2013.)

He believes that when the bubble bursts, the end result will be far worse, since there will be no more room for bailouts. He has been critical of past administrations for failing to reduce spending, leaving the debt burden on future generations.

This is not news to readers of this site, as I have warned of the side effects of the current monetary policy plan set forth by the Federal Reserve. I also try to provide a balanced approach, showing where there are short-term opportunities and how to avoid long-term pitfalls.

The current Federal Reserve monetary policy plan is having short-term positive effects, such as I’ve discussed before with the rebound in the housing and automotive sectors. These parts of the economy are extremely sensitive to interest rates, and as long as rates remain where they are over the next few months, we will continue to see strong results in these sectors.

However, there are costs to this monetary policy stimulus by the Federal Reserve. Once the market senses that the Federal Reserve is about to reduce its monetary policy stimulus, I believe there will be significant volatility, and many sectors will be severely hit.

One area that I worry about is pension funds. Many pension funds, due to the low rates caused by the Federal Reserve’s monetary policy stimulus, are being forced into riskier investments. Junk bond prices are trading at ridiculously high levels, with extremely low yields. Investors have also piled into riskier dividend paying stocks, all in the hunt for yield.

Once the Federal Reserve begins tightening its monetary policy, the value of these investments will decrease significantly. This will mean that the assets on the books for these pension funds will decrease, while the liabilities remain. This is what happened in Cyprus; since a large portion of investments were in Greek bonds, its liabilities (the depositors) remained but the assets decreased.

Now, I am not suggesting that America is Cyprus. But what I am saying is that there are many companies and employees that should be worried about their investments.

The current Federal Reserve monetary policy plan is providing a short-term boost, but I fear the long-term ramifications will be quite costly. If there are massive shortfalls in pension plans, will anyone bail them out? If not, the simple answer is that pension payouts must be reduced or companies will need to raise additional funds.

That is just one issue to worry about as both an employee and a shareholder. In addition, we must worry about the potential for home prices to decline once interest rates start to rise.

For my money, I would certainly avoid any long-term fixed-income investments until the Federal Reserve begins tightening monetary policy. At that point, we will have a better understanding of how the market will react to these shifts in monetary policy by the Federal Reserve and can look for opportunistic investments.

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