Bulls vs. Bears: What Bears Think About the US Federal Reserve

Looking at the US Federal Reserve’s activity from the point of view of the Bear-minded investor.

Last week we put on our Bullish hat on and took up the issue of the monetary policy of our central bankers at the US Federal Reserve. Honestly, we had to stretch a little bit to come up with a truly bullish stance as it relates to Ms. Yellen and her compatriots at the mighty Fed.

It seems that much confidence has been lost in the Fed’s ability to carry out its primary responsibilities to control inflation and encourage full employment. Oh sure, inflation is low, capital is cheap and the unemployment rate is under 5%, but our economy is nearing stall speed, wage growth is weak and most of the jobs on offer are not much to write home about. Many of those jobs are part time and temporary, which means they can go away in a hurry.

Ms. Yellen and her predecessor, Mr. Bernanke authorized the electronic printing of somewhere between $4 and $5 Trillion to buy back US Treasuries and Residential Mortgage Backed Securities to stimulate business investment and reinvigorate the housing market. Yet few economists are willing to hail the efficacy of the so-called Quantitative Easing program that ended in early 2015.

The more bearish crowd thinks it’s more a matter of when than if we all pay a high price in terms of inflation as a direct result of such unprecedented action.

Then add the fact that the Fed Funds rate still hovers near the zero bound as it has for the past six years, and it’s easy to see how pessimism could rule the day.

By keeping money cheap, the Fed also keeps the yield on assets of all types correspondingly low. US Treasury yields, the benchmark no-risk investment that guides investors, are at ridiculous lows. The 10-year T-Bill pays roughly 1.6% right now.

No wonder buyers are happy to buy commercial real estate at cap rates in the 4% to 6% range these days.

That dismal return makes a trophy industrial park purchased at a five cap look like a steal, especially since you can borrow money at under 4% to do it.

And that’s why many believe that the Fed will be the cause of a coming bubble soon to deflate. The same goes for the equities markets. Investors hungry for decent yield have pushed the stock market to record highs during the weakest economic recovery since the late 1940’s.

To coin a popular Bear phrase; that just don’t add up.

The Bears wonder how much sense it really makes that the Dow and S&P 500 are near record highs after 6 straight quarters of earnings declines. Yet, the Bulls keep charging ahead by buying at price/earnings ratios that are getting dangerously high. At what point do these optimists say “enough is enough” and start pulling some money off the table?

That makes the Bears wonder how much dry powder the Fed will have to react to a recession caused by a correction in the equities markets. With interest rates near zero already and an overloaded balance sheet, it’s well worth wondering about. Maybe Ms. Yellen and her Board of Governors will send interest rates into negative territory like their counterparts in Europe and Japan have done. They even have an acronym for that now: NIRP, (Negative Interest Rate Policy). That just don’t add up, either.

If you are a saver, you’re already getting hammered with interest rates where they are. Imagine having to pay to keep your money in a savings account. The Bears fear for all the Baby Boomers who have planned retirement strategies under the assumption that a saver could actually earn interest on his or her hard-earned cash.

That may have been the case 20 years ago, but those days are long gone and your local bank now gives you about the same return as your mattress will. Add the sub-standard yield on trillions of dollars in assets held in defined pension plans (public and private) to the equation and it gets scarier still.

The sad truth of it from a Bear’s perspective is that the Fed has gotten too big for its britches.

They believe the markets are moving too much on its anticipated actions rather than on market fundamentals. Equities markets leap higher or nosedive after a single Fed official’s comments on interest rates hit the airwaves. That means billions if not trillions of dollars change hands by a single person expressing an opinion or making a simple observation.

Back in the days of Fed Chairman, Paul Volcker, the Fed acted on its own volition and interest rate moves, up or down, were made without warning or “forward guidance” as they are today.

So, investors had to look more to market conditions for direction or settle for being late to the party. Now we have a small group, mainly with academic backgrounds, who manipulate the cost and flow of capital based on computer models that don’t seem to work very well. Scarier still is the fact that when the results they measure are less than expected, they double down on the same ideas in the hope of proving the veracity of their own models.

What no one knows and what Bears fear most is the long term consequences of current central bank monetary policy. They are concerned that the Fed lacks the courage to take tough action that will cause economic pain, and that will only delay an inevitable and even more painful reckoning sometime in the near future.

If you own a highly appreciated commercial property asset, you have benefitted greatly from the actions of our central bank. So, you might want to channel your “Inner Bear” and give your real estate strategy a good hard look.