Independent Investor: Can the Fed Avert Another Selloff?

The safe bet would be to write about something else because by the time you read this Federal Reserve Bank Chairman Ben Bernanke will have already given his speech in Jackson Hole, Wyo., scheduled for Friday morning. I'm betting that whatever he says won't be enough to save the stock market from further decline.

The stock market has been climbing over the last week in anticipation that the Federal Reserve will, like last year, announce another monetary stimulus program similar to QE II. There are several problems in betting on that outcome in my opinion.

No. 1 is investor's knee-jerk expectation that the government will save the stock market every time we have a selloff of 10 percent or better. We have become conditioned to expect some sort of governmental intervention ever since the 2008-2009 financial crises. That's when the TARP Plan was passed, followed by the stimulus plan, the extension of the Bush tax cuts and the cut in payroll taxes, not to mention last year's QE II announcement almost exactly a year ago today.

The second problem is that the Fed has already done quite a bit to stimulate the economy with mixed results. Their announcement of just a few weeks ago that they will keep interest rates low until mid-2013 is actually an extension of QE II, (call it QE 2 1/2). I doubt that they will be willing to move much beyond their present efforts until the economic data clearly indicates further weakening.

There has been some talk that the Fed might change its focus from buying short-term U.S. Treasury bonds to buying long-term U.S. Treasury bonds. I am at a loss to understand why they would want to do that. Lowering long-term rates would theoretically make borrowing cheaper. An implicit assumption is that lower rates would encourage long-term investment in plant and equipment. The problem with that theory is that large corporations already have record amounts of cash to invest but are still not investing in long–term projects. They believe there is simply too much uncertainty within our political system, our regulatory environment and in the economy to warrant additional investment right now.

As for smaller corporations, those that represent the majority of America’s work force, only those businesses that don’t really need to borrow are eligible for loans. It is not the level of interest rates that prevent banks from lending. It is the uncertainty that loans to small businesses will be paid back that has created an almost complete cessation of new lending in that arena. It has already been shown (via QEII) that banks are not willing to lend no matter how low rates fall.

In any case, it is not our economy that has been driving markets lower. The financial problems in Europe are what have most investors spooked. Make no mistake, Europe's problems are serious and their leaders have yet to come up with a decisive, comprehensive plan to deal with their financial problems. The Fed's actions here won't resolve the problems on the other side of the Atlantic.

In summary, unless the Fed pulls a bull-sized rabbit out of their hat tomorrow, the markets will swoon. Let's see what happens.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at wschmick@fairpoint.net . Visit www.afewdollarsmore.com for more of Bill's insights.