Bernanke's Conundrum and the Investment Opportunities It Creates

By: Money_Morning

Good morning!

As I head to China, I'm struck by the irony of Bernanke's continued assurances this week that he'll head off inflation by selling assets and shrinking the monetary supply when the time comes. Not because I don't believe that he'll try - he will - but because I don't think he can.

Here's why:
1. Bailout Ben, Turbo Tim and a whole host of other characters in the current and preceding several administrations completely missed the credit crisis in formation. Worse, they insisted until the very end that the economy was doing just fine when it wasn't. How are "they" now miraculously going to judge that the economy is in recovery and when will they do it?

Like Greenspan who finally admitted under great pressure (and well after the fact) that he had several flaws in a lifetime of economic thinking, Bernanke risks doing too little too late. Or, too much, too early. If he waits and keeps rates too low too long he risks a repeat of Big Al Greenspan's legacy. If he jacks up rates too soon, he kills the recovery and goes down in history as the guy that cratered the world's recovery. I don't envy him either way.

2. By injecting trillions of dollars into the markets to prop up functionally insolvent companies, the Fed is making matters far worse instead of better. Not only that, but somebody is going to have to pay all of that back and, sadly, that burden will fall to taxpayers, many of whom have actually been responsible with their money.

The Fed, now fully ensnared in this mess, can no more raise rates to cope with inflation when it hits than a drug dealer can give up crack. Think of this as the mother of all adjustable rate mortgages. If the Fed raises rates, it increases the costs of refinancing all of this nonsense. If it doesn't, it risks the unthinkable...a devaluation of the US dollar. I hope we all don't become Zimbabwe trillionaires in the process!

3. Bernanke has stated that he intends to sell assets as part of his plan to reduce the monetary supply and clean house a bit. That's great when you're buying stuff that's freely available on the open markets like treasuries or the US dollar, but nearly hopeless when you're buying trash like toxic debt that nobody else wants like the Fed is now. It'd be one thing if the Fed was bidding against other market participants, but let's not forget Team Fed is playing risk taker of last resort because the best investment banks in the business couldn't sell the stuff Washington is buying. Which is, of course, why many are destined to be out of business.
So where does that leave us?

Ironically, inasmuch as Bernanke's got his own version of Greenspan's "conundrum" on his hands, the Fed's liquidity program will probably create its fair share of unanticipated opportunities.

Of the many I'm watching right now, two, in particular, stand out as having the potential to help investors rescue their portfolios and get back on track:

1. History suggests that cash rich, low debt companies dealing in real products stand to weather the storm best and lead the way out of this mess, particularly where commodities, agricultural products and infrastructure are concerned. Moreover, if we haven't hit the bottom yet, history shows they're less prone to fall or simply not likely to fall as much. So this is good...upside plus stability.

2. Income investments tend to outperform other choices throughout a recession but also tend to recover faster than their non-dividend paying brethren when the smoke clears. The trick is knowing which companies really are worth the cash and not the trash. Energy MLPs are particularly compelling right now as are several choices in the - gulp - junk bond market. Both stand to benefit not only from the misguided stimulus plans now in play, but also legitimately from the recovery when it finally starts in earnest. My colleague Martin Hutchinson has several great plays he's working on too-and you can hear the details, as well as his thoughts on the shocking "yield gap" in a free video presentation he's giving on Tuesday April 21. Don't miss it.

Best regards,

Keith
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