Boiling Point: The ‘Bernanke Put’ On Trial

September 30, 2010

David Tepper may be a superstar, but I have to throw the flag on his view that now is the time to buy stocks.

In my recent piece titled “Right Back Where We Started,” I highlighted the idea that financial markets are at an inflection point. The legendary David Tepper of Appaloosa Management articulated a very similar premise on CNBC recently, but reached a slightly different conclusion than my own.

Chadd BennettTepper has been and remains a bond expert, and suddenly he likes stocks more than usual. While this caused many bears to question their own arguments and helped stocks rally after he spoke last week, it’s still time to stay flexible.

If you’re into ETFs, cash-alternative securities like Pimco’s Enhanced Short Maturity Strategy Fund (NYSEArca: MINT) or inflation hedges like the SPDR Gold Trust (NYSEArca: GLD) seem a lot more sensible.

Combining his macro views with what he sees as unusual opportunities like we saw in March 2009 in financial stocks, he has averaged returns between 30 and 40 percent over the past 15 years. While he still has 70 percent allocation to fixed income, lately he’s bullish, short term, on stocks.

His basic idea is that there are two possible scenarios that will play out over the next three to four months, and that either way, stocks will do OK.

In one scenario, the economy will improve on its own and stocks would do well, but gold and bonds would lag. In the second scenario, the economy would start to slow again and the Fed would come in with more quantitative easing. That would be good for bonds—in the short term, at least—as well as gold and stocks.

The "Greenspan Put" On Steroids

They used to call the Fed’s impulse to rescue the stock market the “Greenspan Put.” Tepper says recent Fed statements indicate the Fed is committed more than ever to that sort of reflexive policy and, crucially, that the “Bernanke Put” is like a turbocharged Greenspan Put. He can’t remember any other time in the Fed’s nearly 100-year history that it has so explicitly accepted inflation as a necessary evil in stimulating the economy.

Traditionally the Fed would cut rates to counter falling stocks and a worsening economic situation. It could also make official statements or use the occasional speech by one of its officials to let the markets know what its aims were. Now however, with rates at zero, it has to back to up its jawboning by actually injecting cash into the economy through these extraordinary bond purchases we call QE.

While I agree that these measures by the Fed are unprecedented, I believe there’s an important third scenario that may already be rearing its head. The way I see it, the market may not let the Fed carry out QE II, and I never heard Tepper address that possibility.

A market rejection of Fed policy would most likely be evident in dramatic increases in metals and commodities that, ultimately, would almost surely be followed by rates moving higher. Stocks would most likely jump initially as the Fed’s new policy efforts took shape, but smart money would sell into the rallies. The stock market, by moving downward, would essentially be saying that the rise in commodities prices isn’t sustainable.

It seems to me we’re already seeing the warning signs of my third scenario in the outperformance of gold and other precious metals.

Moreover, the U.S. dollar index has also broken a key technical level of 80. The last time we saw a move down through this level was in the autumn of 2007, after which it fell another 12 percent, helping crude oil double in price over the next eight months. That was unsustainable, to say the least.

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