Will The Fed’s Money-Printing Lead to Ruin?
Lest I get inundated with pedantic emails trying to correct me, let me first acknowledge that the Federal Reserve doesn’t literally print money. The Fed can’t produce physical money in the form of coins or bills. That’s the job of the Bureau of Engraving and Printing (which is run by the U.S. Treasury) and the U.S. Mint.
However, the larger truth behind the metaphor remains valid. The Fed expands (or contracts ) the money supply by purchasing (or selling) U.S. Treasury securities and other financial instruments.
The Fed pays for those securities by crediting funds to the reserves that banks are required to hold. The Fed “prints money,” so to speak, by adding reserves to the banking system. These additional reserves also enable banks to make more loans, which stimulates the economy.
What’s the major factor driving stocks to record highs despite an economic recession and abysmal corporate earnings growth? Massive stimulus, courtesy of the U.S. central bank, as a means to counteract economic damage from the coronavirus pandemic.
According to the Fed’s latest report to Congress on August 8, the Fed’s balance sheet has ballooned to $7 trillion as it buys everything from U.S. Treasurys to mortgage backed securities.
Problem is, the Fed is buying a lot of corporate debt that’s toxic, which in turn is creating “zombie” markets that are mispriced and distorted. The Fed also is buying the debt of hugely profitable companies that don’t even need the help. Many of the recipients of this largess remain a secret.
We face a reckoning, when these imbalances finally catch up with fundamentals. Key policymakers in Washington, DC already know this, but they’re trying to keep the asset bubble inflated until after the November election. A financial storm is brewing. Below, I’ll steer you toward investment opportunities that can shelter your wealth.
In the meantime, FOMO (Fear of Missing Out) reigns. The three main U.S. stock market indices Wednesday rose as follows: the Dow Jones Industrial Average (+1.05%), the S&P 500 (+1.40%), and the NASDAQ (+2.13%). Stock futures Thursday morning were trading lower.
There’s an old saying on Wall Street: Don’t fight the Fed. So, let’s enjoy the rally while we can. But make no mistake, risk-on assets are poised to take a drubbing.
If stock prices are supposed to represented future projected earnings, the math doesn’t add up. For the second quarter of 2020, the blended earnings decline (on a year-over-year basis) for the S&P 500 is -33.8%. If -33.8% is the actual decline for the quarter, it will mark the largest year-over-year decline in earnings reported by the index since Q1 2009 (-35.4%).
Analysts predict a year-over-year decline in earnings in the third quarter (-22.9%) and the fourth quarter (-12.8%).
And yet, the forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is 22.3. This P/E ratio is above the 5-year average (17.0) and above the 10-year average (15.3).
A better indication of the market’s frothiness is the cyclically adjusted P/E ratio (CAPE). The widely respected Professor Robert Shiller of Yale University invented the CAPE ratio (also known as the Shiller P/E) to provide a deeper context for market valuation.
The CAPE ratio is defined as price divided by the average of 10 years of earnings (moving average), adjusted for inflation. The ratio currently stands at 31.23, which is 97.7% higher than the historical mean of 15.79. CAPE valuations currently exceed those of 1929 and 1987, two inauspicious years for the stock market.
The earnings growth leader…
Where should you turn as an investor? One sector stands above the fray and it’s utilities stocks. The utilities sector is currently reporting the largest year-over-year earnings growth for Q2 (8.9%) of all 11 S&P sectors (see chart).
At the industry level, four of the five industries in the utilities sector are reporting year-over-year growth in earnings: multi-utilities (24%), gas utilities (21%), electric utilities (4%), and water utilities (1%). The independent power & renewable energy producers industry is the only one reporting a decline in earnings (-4%) for the quarter.
For an effective “defensive growth” hedge, turn to utilities stocks. Follow this link for our favorite utilities picks.
Corporate fire sales…
There’s a disconnect between the broader economy and the stock market. Bankruptcies are rising but stocks have been rallying. As the pandemic crushes thousands of businesses in a wide variety of industries, we’re seeing an uptick in the acquisitions of financially troubled companies. You can leverage this trend to your profitable advantage.
Takeover initiatives are emerging as sources of investment opportunities. My colleague Nathan Slaughter understands this dynamic better than anyone on Wall Street.
As chief investment strategist of Takeover Trader, Nathan is an expert on mergers and acquisitions and corporate takeover initiatives.
Nathan is adept at digging up the inside data on pending takeovers. Along those lines, he’s about to go on camera to reveal a startling development. If you watch his presentation and follow his advice, you could reap huge market-beating gains.
Nathan will lift the curtain on the one hidden asset that’s about to attract $4 trillion of cash from America’s richest CEOs. These powerful insiders have pinpointed a future bonanza and they’ve decided to go “all in.” This is your chance to join them. To lock in your free spot for Nathan’s “Project Rainmaker” expose, click here now.
John Persinos is the editorial director of Investing Daily. You can reach him at: firstname.lastname@example.org