September 13, 2012 at 10:43 AM EDT
The Fed Better Not Let Us Down


Fed failure If the Federal Reserve were to fail to act, I expect we would see a good deal of the stock market gains made since June unravel before our eyes. The Fed must act today, because expectations are so deeply built into valuations that such a failure could be a catalyst for a crash, and a crash in itself can cause a recession. Of course, the Fed is not called to support stocks, but it is in its interests to protect employment and guard against inflation. In order to protect employment, not just aid it, the Fed must support the economy and economic certainty, which is currently in question.

federal reserve columnist I’ve noted my view that what the Fed has to offer is analogous to a child’s floatie for the management of an economic storm. Nonetheless, the market has high hopes today for Federal Reserve action. So even as I view the Federal Reserve only peripherally effective at this point, and mostly just supportive; and even as I argue that central banks are working their way toward putting the world in a place vulnerable to external shock damaging to global fiat currency (favoring gold), I say today, the Fed better not fail us.

Since early June, when real hopes in the Fed began to build, the SPDR S&P 500 Index ETF (NYSE: SPY) has gained 13%. Stocks, as seen by action in the SPY and in the moves of European shares (seen in the iShares S&P Europe 350 Index (NYSE: IEV)), got an extra lift when Mario Draghi issued his famous statement at the end of July. I labeled then a mess of his own making because of the time it is taking for ECB follow through to actually occur.

Earlier this week, the German court action to ratify Germany’s approval of the European Stability Mechanism (ESM) finally gave credence to Draghi’s conviction. Today, the Federal Reserve has an opportunity to solidify hope, and to support the life of stocks and the very relative economic relationship between the market and the economy. The chart of cyclical stocks like Caterpillar (NYSE: CAT) offer insight into how far we might fall, if not further, if the Fed lets the market down today. The same goes for the cyclical financials like Citigroup (NYSE: C) and Bank of America (NYSE: BAC).

Much hangs in the balance as you can see. If the Fed lets us down today, you can expect a significant market downslide. I even believe a Fed miscue could drive a mini-crash given the level of expectations built into stocks, which otherwise seem to lack good reason for their rally since June.

In my estimation, it really only buys the market some time. If global economic conditions were to hold steady in the meantime, or only deteriorate slightly further, then perhaps yet another Fed action (and ECB action) might give the world a minute more to wait for it. However, it is my view that over the longer term, it will become increasingly evident that we are just at the start of a new recession. As the data continues to come in through that span, I think reality will sink in. And given that my geopolitical concerns appear to finally be proving tangibly relative, my conviction about global recession is increasing. At that point, the only lasting beneficiary of central bank actions will be gold and relative securities like the SPDR Gold Series Trust (NYSE: GLD), and other precious metals and agricultural commodities; also companies serving agriculture like Monsanto (NYSE: MON). Real estate and other hard assets should also see price increase, but on fiat currency decrease. Still, for now, the Fed better not let us down.

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