Fight Your Urge to Fight the Fed

BALTIMORE ( Stockpickr) -- "Don't fight the Fed" may be trite advice these days, but it's right.

The S&P 500 has been on a wild tear for the last 10 months, up more than 18% since the start of last June. But now, after a week of corrections in the broad market, investors are wondering if something's changed. After a multi-year rally in stocks, is Ben Bernanke wrong from here on?

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My money's on a resounding no.

For the last five years, a big group of investors has been outraged at the Federal Reserve's willingness to pump money into the system. A Google search of the words "Bernanke" and "immoral" yields 4.9 million results; the Fed Chairman isn't making many friends for his efforts. But I think that a lot of investors are missing the bigger story here: Wrong, right or indifferent, you can't fight the Fed and make money.

I doubt anyone thinks that our central bank dumping cash into the economy is ideal. But it seems like too many investors think he has a choice. He doesn't.

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A few weeks ago, I was at the Market Technicians Association symposium in New York. One of the speakers, CNBC contributor and SkyBridge Capital founder Anthony Scaramucci, made an unfortunately insightful comment: "Chairman Bernanke is the only functioning member of the government right now!"

To be clear, Scaramucci is hardly a Fed apologist. His point is that the Fed is fighting one of its most menacing foes: deflation.

Even though the "traditional" gauges of inflation are reading positive, a more fragmented look at prices shows that while some prices have gone up, other assets have actually deflated pretty significantly post-recession. Based on the yardstick the Fed used in the two and a half decades leading up to the Great Recession, Bernanke and his cohorts would actually have to turn the Federal Funds Rate negative in order to meet their rate objectives.

So instead, they're throwing money at the problem until it goes away.

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It's not that the Fed wants to punish savers and spark huge inflation. The fact is, with rates already skimming the ground, they're out of tools.

That hasn't stopped a big group of investors from shaking their fists at the Fed. But all the while, the investors who bet with Bernanke and company have been banking substantial gains. I think that will continue to be the case in 2013, and here's why.

You Don't Have Any Other Choices

Like it or lump it, you can't escape the Fed. While many investors turned to gold as an alternative "currency" vs. the inflated dollar, the recent breakdown in gold prices shows that everyone's favorite metal isn't exactly a low-risk option. Since before the recession, gold prices have ballooned to a 50% premium over the CRB Spot Raw Industrials Index, a basket of non-traded industrial commodities. That suggests speculation, not inflation, fueled much of gold's ascent.

There's nothing wrong with speculation, but investors have to remember that it can work in both directions. And now it is.

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When the Fed throws cash out of its helicopter, correlations in financial markets worldwide ratchet higher (or, more technically, the absolute value of those correlations does). In English, that means that it suddenly becomes nearly impossible to find a place to park your money that doesn't ebb or flow with whatever the Fed's buying.

You can't escape it -- and that makes fighting the Fed a pretty pointless proposition.

Interest Rates Are No Longer a Free Market

The Fed's impact on the interest rate market is another reason to watch Bernanke's moves in 2013.

For better or worse, interest rates are no longer a free market. Instead, the Fed clearly has its thumb on the scale.

That's why interest rates remain so low right now. With rates near zero for the long term, the common wisdom for the last five years has been that rates are due to turn higher. The market wants higher rates (and major market participants continue to bet publicly on higher rates), but as long as treasuries can catch a bid from the Fed, interest rates will continue to hug the deck.

Like a lot of other market analysts, I've been a proponent of the so-called "Great Rotation" from treasuries to equities for a while now, but it's failed to materialize so far because of that same flow of Fed cash. If nothing else, that's still a big catalyst for upside in stocks longer-term -- not because the Fed will eventually lose its battle against interest rates, but because Bernanke and company will eventually feel a lot more comfortable letting the market push rates up again.

There's still a lot of cash waiting to make the move from bonds back into stocks.

How to Bet With the Fed

Want to bet with the Fed in 2013? The simple answer is dividend stocks.

High-quality dividend payers are continuing to outperform this year, buoyed by this continued low-rate environment and driven by record corporate cash and profitability. In short, large-cap U.S. stocks have the wherewithal to generate yield for investors in a market where that's still extremely hard to come by. So far, those yields have largely kept up with price appreciation in stocks because fundamentals have moved with stock prices in lock step.

I'd expect those yields to erode (thanks to price increasing, not dividends dropping) just before we see a meaningful rotation away from fixed income.

At the same time, index funds such as the SPDR S&P 500 ETF ( SPY) and the PowerShares QQQ Trust ( QQQ) should continue to show investors strong performance in 2013. The liquidity-driven rally promulgated by the Fed isn't just putting a floor in treasuries; it's also been supremely effective at shoving stocks higher.

The bottom line is this: You can disagree with what the Fed's doing. You can argue that the dollar is doomed or that we're months away from hyperinflation. But you can't fight the Fed and expect to make money in this market.

As Ned Davis is famous for saying, There's a difference between being 'right' and making money."

And investors who want to make money should still buy stocks.

-- Written by Jonas Elmerraji in Baltimore.


Follow Stockpickr on Twitter and become a fan on Facebook.

At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to
TheStreet . Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily , and on Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.

Follow Jonas on Twitter @JonasElmerraji

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