According to the official website of the Government Accountability Office, investors in the S&P 500 rejoiced on the Fed buying corporate bonds. How? Let’s examine that angle and discover if the Fed’s handiwork is really good for the stock market.
We’ve known for a long time that central banks, especially the Federal Reserve, are propping up the stock market. They do this by buying and selling stocks. When the stock market continues to go up, the Fed buys more stocks, causing the price of stocks to go up, and then when the Fed is about to sell the stocks, it will buy a little more so that the stock prices will continue to rise.
The market is not making any money. The rate of interest is too high. And all this is happening because the Fed is actively trying to inflate the bubble. The question is how effective will this strategy be?
If the Fed continues to pump up the stock market, and then drops it, when will investors begin to rethink the strategy? When will they realize that the bubble has burst?
Of course, that’s only a question if you think the stock market is the future of the U.S. economy. If you believe that the stock market can be part of the engine of a strong economic growth in the future, then the investment strategy should be considered quite different.
It makes sense for the average investor to use a strategy that focuses on equities. While there is no guarantee that a stock market will grow faster than the economy, there is no doubt that a well-managed, consistent stock market can outperform the economy. While a slower growth is certainly better than an inflated bubble, the future of the world economy is secure if the market can be sustained at a reasonable rate.
For people who want to see a strong future for the stock market, the safest strategy is to follow the investing advice given in Ben Graham’s famous “Security Analysis” paper. That’s what I would do if I were in charge of investing my savings.
Rather than looking at the stock market and hoping for a big rebound or some other external event to change the state of the economy, the best strategy is to invest in a systematic way. You need to take your time and learn the ins and outs of the market.
The Fed has pumped up the stock market, but it will never create a sustainable economy if the stock market can’t be sustained. You need to learn to manage risk and you need to learn to manage liquidity.
One of the best ways to manage liquidity is to invest in government securities, such as government bonds. Those who follow the principle of balance between equities and bonds should understand that the Fed will stop buying bonds when the stock market reaches its bottom.
But what happens if the stock market begins to fall? What if the Fed decides to pump up the stock market to make it look like the economic recovery is accelerating?
Then, when the stock market crashes the price of government bonds will drop, and then you’ll know that the Fed has had a bad day.