Are You Feeling Lucky?

I know what you’re thinking, punk. You’re thinking: “Did he fire six shots or only five?” Now to tell you the truth I forgot myself in all this excitement. But being this is a .44 Magnum, the most powerful handgun in the world, and will blow your head clean off, you’ve gotta ask yourself a question: “Do I feel lucky?”

Well, do ya, punk?

– “Dirty” Harry Callahan, Dirty Harry

The Dow finally broke its losing streak yesterday. It rose 55 points. Gold fell $12.

Nothing dramatic. Nothing conclusive. Or even persuasive.

Stocks are going up… or down. No one knows for sure.

We’re not gamblers. So we’re out of US stocks… and our “Crash Alert” flag flies… not because we think stocks are going down, but because we think the weight of risk lies on the downside.

That said, the feds have added $3 trillion in cash and some $23 trillion in credit guarantees over the last five years. Something had to happen to the money, right?

Don’t bother looking for it in the trailer parks. Hourly wages are no higher. And fewer people (as a percentage of the workforce) have jobs than ever before.

Household incomes are stagnant. So you won’t find it under middle-class seat cushions, either…

Real estate? Ultra-low mortgage rates hardly hurt…

But only stocks have skyrocketed…

According to former Merrill Lynch economist David Rosenberg, since the March 2009 low there has been a near-perfect correlation between a higher S&P 500 and the expansion of the Fed’s balance sheet.

So, we can plausibly assume the Fed will continue to push up stock prices – at a rate of about $85 billion per month… or about $1 trillion a year.

Perpetual Money Pumping

We may even assume that, by back-tracking on its own forward guidance, the Fed has now embarked on a new stage of perpetual money-pumping. And that investors might now anticipate trillions more dollars’ worth of stock buying.

From bearish fund manager John Hussman:

Investors may draw on this decision as evidence that the Federal Open Market Committee (FOMC) has placed a safety net below the market… and that the surprising extension of its current policies could spark a short-term speculative blow-off top.

We don’t deny it. Under these conditions, the bulls might be right. They might bet on a blow-off with much higher stock prices. They might make money.

Dear readers who are feeling lucky might take a chance. Buy some call options. Who knows? They could pay off big!

But dear readers are warned: Gamblers gotta know when to fold ‘em… and know when to walk away, too.

A bet on a blow-off top is a bet that: (1) the economy is not really recovering, (2) the Fed won’t taper, (3) with no real recovery, the cash goes into speculations, and 4) the most likely speculative market is stocks.

This is not a bad bet. “As long as the music is playing, you’ve got to get up and dance,” said former Citigroup boss Chuck Prince. But it’s risky. Because they don’t hold up cue cards to tell you when they’re going to pull the plug. Instead, as the end approaches, the party grows wilder and wilder.

Ah yes, dear reader, they don’t make it easy. The closer you are to disaster, the harder it is to leave. Just before the blow-off turns into a blow-up, stocks are typically going straight up. Who wants to leave the party then?

But when the lights go out, suddenly everybody rushes for the exits. But it’s too late. Bodies pile up in the doorways. It is impossible to get out.

The Bitter End

The same is true of the entire Fed intervention. The more the central bank intervenes, the more dependent the economy becomes, and the harder it is to exit. They say they will head for the door when the numbers improve… but as soon as they make a move to the exit, the numbers will collapse.

In this sense, too, the bulls are reading the latest Fed announcement correctly. The Fed will keep at it until the bitter end. It will feed the market with more cash and credit. Then it will find it impossible to back up. Instead, it will keep going until we get a blow-off top in stock prices.

The bulls don’t realize they are subject to the same phenomenon: Gambling on a blow-off top is hard to stop. Gamblers do not walk away from 100%-a-year gains. They stay at the table… and go right to the end… from the blow-off to the blow-up.

There’s a better way to play this situation. By “anti-gambling”…

More next week…

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Market Insight:

How to Play the Coming
Interest Rate Rise

From the desk of Jim Nelson, Editor, Legacy Income

Two months ago, Diary publisher, Will Bonner (Bill’s eldest son), and I started an “experiment.”

Our aim: to convince Bill and as many of his readers as possible that dividend investing is the single best way to build wealth.

We started off with an open debate between Bill (a skeptic) and yours truly. (You can find that debate here, here and here.)

I also agreed to open up a beta test of my new income investing advisory service, Legacy Income, to 500 of Bill’s readers.

Today, I want to update you on how that experiment is going. I also want to tell you why I believe the Fed’s meddling in the markets is going to lead to the mother of all “blow-ups” in bonds… and how you can protect your portfolio.

If you are new to Bill’s Diary, my name is Jim Nelson. I’ve been writing about dividend investing for the better part of a decade.

I wasn’t always a dividend investor. I started out investing in small-cap stocks. But the empirical evidence in favor of dividend investing was too impressive to ignore.

I’m a big fan of empirical evidence, by the way. Too many investors choose their strategy based on their “gut” feeling. I prefer to invest using an approach that’s proven to work over time.

Since 1972 S&P 500 stocks that pay a dividend have returned 37 times more than non-dividend payers. And dividend-paying stocks have smashed non-dividend paying stocks over 5-, 10-, 20- and 30-year timeframes too:

I believe investing for dividend income is going to be even more successful over the coming years. That’s because, like Bill, I believe we’re getting close to a big wipeout in the bond market.

You see, some people think the Fed’s QE is new. But during war and post-war eras, the Fed propped up the bond market with open market purchases of Treasurys – just as it is doing today.

The big difference is that, back then, the Fed was much more reluctant to interfere with market pricing.

The Battle for the Fed

In the war and post-war eras, an aggressive White House and Department of the Treasury joined forces to strong arm the Fed into buying government debt to “peg” interest rates so the US could cheaply fund its war efforts.

When the war ended, the Fed wanted no part of that anymore. Inflation was on the rise. By 1947 inflation had peaked at over 14%. But 10-year Treasury notes were yielding no more than 2.5%.

After repeated efforts and massive infighting (including the firing of Marriner Eccles from his post as Fed chairman), in 1951 President Truman invited all the members of the Federal Open Market Committee – the Fed body responsible for monetary policy decisions – to the White House to discuss a compromise.

It was the fallout from the so-called 1951 Accord that gave birth to the modern Fed. The Fed successfully resisted the White House and Treasury Department’s attempts to force it to continue monetizing debt. Interest rates rose. And a bear market in bonds began.

This chart shows what happened to the yields of Treasurys with maturities longer than 10 years. (Remember, bond yields rise when bond prices fall.)

Today, we face a similar situation. The Fed is monetizing government debt. This is holding interest rates at artificially low levels. An inevitable bear market in bonds is coming.

The 1951 Accord ended a 30-year bond bull market. And started a 30-year bear market. A 32-year bull market followed. We’re now in year 32 of that rally. What do you think will happen next?

The “Boomer Factor”

As bonds enter a bear market, investors will start seeking better returns in the stock market.

There are 78 million American baby boomers starting to retire right now. And they are likely to want one thing above all else: safe income.

But traditional dividend-paying stocks – although in line for huge inflows from this retiree investment – aren’t the only place the boomers will go in their hunt for safe income.

There’s another class of income investment that’s poised to take advantage of the move by boomers out of bonds and into income-paying equities.

Better still, these investments are high yielders. The two I like the most pay 7% and 11%, respectively. That’s more than four times what the average S&P 500 stock yields.

I shared these two plays with beta testers of my new service yesterday afternoon.

The best part about these plays is that this special class of income investment will be even more profitable if Treasury yields… and interest rates… continue to rise.

They also carry significant tax advantages.

Stay tuned next week for more…

[Ed. Note: If you missed out on becoming a beta tester for Jim’s new service, don’t worry. We’ll shortly be giving you an opportunity to check out everything his beta testers have seen… plus lots of new income recommendations.]