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Tuesday, October 15, 2013

The Janet Yellen Era Begins Soon – What It Could Mean to Investors
By Louis Navellier

As our political leaders struggle to re-open the government before running out of cash, President Obama took a break from the political maelstrom to officially nominate Janet Yellen to succeed Ben Bernanke at the helm of the Federal Reserve. Despite rising dissent from the “hawks” on the Fed’s board, Ms. Yellen promptly assured the markets that “QE” would continue saying that “more needs to be done to strengthen the recovery” and “too many Americans still cannot find a job and worry how they will pay their bills and provide for their families.” Translated from Fedspeak, this means that she will likely use the unemployment rate as a guide for keeping QE in place, meaning any “tapering” will likely be postponed until next year.

In Britain, The Telegraph said of her nomination: “Rejoice: The Yellen Fed will print money forever, to create jobs.” But my associate Ivan Martchev begs to differ with the assumption that the Fed can “print money.” Last May, Ivan wrote an article for Marketwatch (“The Alchemy of Printing Money without Ink”), right after Bernanke’s “tapering” remarks. His analysis last May proved to be right on the money.

Since the Fed says it will maintain its near-0% interest rate policy well after it tapers or ends QE, I asked Ivan to analyze the Fed’s role during this coming Bernanke/Yellen transition period and then suggest a possible solution for income investors to consider in these times of ultra-low interest rates.

In This Issue

The Myth of a “Federal Reserve Printing Press”
Why Bernanke Decided NOT to “Taper”
Implications for Income-Oriented Investors

Why Bernanke Panicked, and How You Could Profit from “QE-4ever”
By Ivan Martchev

Before this QE business started, I thought the word “taper” was a barbershop term. I would walk into the Village Barbers in Maplewood, NJ and Bernie (the barber) would invite me to sit. After exchanging the customary pleasantries, the question would always arise, “How would you like me to cut your hair today, straight or tapered in the back?”

Then came May 22, and Fed Chairman Bernanke turned a barbershop term into a sophisticated central banking maneuver. The bond market panicked, thinking that all of sudden the endless flow of money would stop and terrible things would happen to anyone investing in stocks or bonds.

Then, Bernanke changed his mind. By the time you read this, four weeks will have passed since the infamous decision of the Federal Reserve on September 17 to refrain from QE tapering. Most investors were mightily surprised – but not me. Some bought stocks that day. Others bought bonds, but many remained worried that this great quantitative easing experiment would end badly, with high inflation or worse.

While I understand those worries and admit they have validity should a policy mistake occur at the Federal Reserve, there is a real chance there will be very little inflation resulting from QE policies.

How so? Didn't the Fed just print a gazillion dollars?

The Myth of a “Federal Reserve Printing Press”

It is easy to think that if you have a certain amount of money in circulation – and if you print more of it – you will get more money chasing the same amount of goods and services, so the purchasing power of the freshly-minted money will decline. People think Ben Bernanke is like some old-fashioned print shop manager with his little visor, his apron, and his sleeve protectors, checking up on his printing presses all day. His job is merely to make sure (a) they have enough ink, and (b) they have enough paper.

I am here to tell you there is no such thing as a “Federal Reserve printing press.”

Quantitative easing is a game of interest rates, not an amount of money. QE is designed to prevent the freshly-minted cash from doing damage to the financial system. Freshly-minted QE cash may slosh around in the system for a short while, but it ends up as excess reserves warehoused at the Federal Reserve Bank of New York (FRBNY).

If the Federal Reserve pays interest on these excess reserves that is higher than the Fed Funds rate – and that has been the case since 2008 – then no bank with excess reserves will lend money into the interbank market, since it can hold the excess reserves at FRBNY for a higher rate of return. The bank can lend excess reserves, but those loans end up as excess reserves at another bank. And if that other bank can’t make a good loan, it again ends up earning excess reserve interest at FRBNY. The total excess reserves in the banking system do not change due to commercial bank lending, and are always controlled by the Fed.

In short, electronically-minted QE money is used to keep long-term interest rates lower than they would otherwise be, and…that…is…all.

If you look at Table 2 in the Federal Reserve’s “Aggregate Reserves of Depository Institutions and the Monetary Base – H.3” release, you will note that Total Balances Maintained never seems to stop going up (because of QE), but Currency in Circulation stays relatively flat. While QE causes the Monetary Base to explode and literally freak people out, the excess reserves of monetary institutions have no multiplier effect. They don’t grow in the fractional reserve banking system the way they did when there was no interest paid on excess reserves, prior to 2008. (I explained all of this in greater detail on Marketwatch last May 23 after Bernanke’s “tapering” remarks. See: (“The Alchemy of Printing Money without Ink”)

Why Bernanke Decided NOT to “Taper”

Unfortunately, there is too much Treasury debt, as the federal government spends much more than it collects. Without the Fed’s QE maneuvers, long-term interest rates would be higher. If long-term interest rates were higher, the real estate market would heal more slowly and employment would be rising more slowly. So, if QE does not produce inflation and helps increase employment, the Fed will keep doing it.

One trouble with the U.S. economy, though, is that 30 years of falling interest rates have made people complacent and caused them to use too much leverage in the system. Total leverage – corporate, financial, government, and consumer – is about 350%, which is very high by historical standards. It is higher than what we had in the Roaring ‘20s, just before the Great Depression. The excesses of the 1920s were followed by a prolonged period of de-leveraging and numerous policy errors by the Federal Reserve, the President, and Congress, including the 1930 Smoot-Hawley Tariff Act. I am convinced the Fed’s QE operation is an elaborate maneuver to stop de-leveraging and save the system from a rerun of the 1930s.

It is difficult to stop or “taper” QE given the low inflation we see today. The Fed’s favorite inflation measure – the Personal Consumption Expenditures ex-Food and Energy – is rising at a 1.2% annual rate at last count (August). The Fed would like to see that rate closer to 2%. A financial system that has high financial leverage, like ours, cannot tolerate low inflation or, worse, deflation, which would cause a serious hit to corporate, government, and consumer revenues, which in turn would make debt servicing difficult. With inflation so low, an accomplished monetary economist like Ben Bernanke passed the delicate but inevitable tapering decision on to the incoming Fed Chairwoman, Janet Yellen.

Implications for Income-Oriented Investors

Dividend stocks have been affected most by the gyrations over QE expectations. Navellier offers several dividend/income strategies that are affected in different ways by Fed policies.

Navellier’s Power Dividend strategy does not just seek the highest yield. It also behaves differently than strategies that focus on classic dividend stocks, like utilities and telecoms. In particular, we typically target high-quality stocks paying at least 150% of the market dividend yield, on average, with the ability to grow those dividends, as determined by our proprietary methodology.

We are developing a Dividend Persistence model, ranking companies on their ability to pay and maintain a dividend. In this model, a company that has a low dividend yield, but the ability to pay a much higher dividend, as well as strong dividend growth, will typically get a high rating, while a company that has a high dividend yield but insufficient cash flow to maintain it will typically get a low rating.

Historically, stocks that pay dividends or have initiated dividend payments, have typically offered considerable long-term performance advantages over non-dividend paying stocks. Furthermore, stable and growing dividends typically offer the potential for greater stock price stability, acting as a moderating effect against large price swings during weak market periods. We believe a high and growing dividend yield can help reduce a stock’s volatility compared with non-dividend paying stocks. Dividend stocks are sensitive in the current QE gyrations in the bond market, but dividend yields have the ability to grow if inflation ever becomes problematic.

In short, the Navellier Power Dividend Portfolio seeks to offer above-market dividend yields.



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