Bernanke Blinks!

Staring down the gun-barrel of the worst credit crunch at least since the implosion of Long Term Capital in 1998 – and perhaps since the U.S. Savings & Loan crisis of the late 1980’s – the Federal Reserve once again called on the old reliable reflation play yesterday.

Fed Chairman Ben Bernanke essentially said: "I love the smell of freshly minted money in the morning"; so fire up those printing presses, and crank up the credit-choppers – helicopter-Ben is on the job.

In case you missed the fun yesterday afternoon, here’s a recap: Following up on the first appearance of the Plunge Protection Team about one-month ago with a surprise half-point cut in the discount rate, the FOMC yesterday matched that easing with a 50 basis point cut of its own in the more closely watched Fed funds rate.

Saying that “the tightening of credit conditions has the potential to intensify the housing correction, and to restrain economic growth”, the FOMC voted unanimously to rush to Wall Street’s… er, that is... the economy’s aid, by taking a full 50-basis points off its benchmark lending rate now. In other words: over-react now, and lose all credibility as an inflation-fighting institution in the process.

No surprise that along with across-the board stock market gains, investors also witnessed gold soaring above $730 an ounce, oil crack $82 per barrel (both on the way much higher) and the U.S. dollar sink to yet another record low!

Delaying the Financial Day of Reckoning

Indeed, all the Fed has succeeded in doing is to postpone the inevitable day of financial reckoning on Wall Street. It has bought some time, by issuing a new round of Bernanke Puts – but at what cost?

At its present rate of decline the U.S. dollar, not so long ago the world’s preferred, will more closely resemble the currency of a 1970’s-era banana republic – except those countries south of the border at least had natural resource riches to prop them back up.

Another tangible cost will almost certainly be paid in the form of much higher structural inflation down the road. For investors with portfolios top-heavy in U.S.-based assets this represents a double-threat to purchasing power and asset values from BOTH a sinking currency and the corrosive impact of inflation. It’s a threat not to be taken lightly.

Housing Remains in Recession, Which the Overall Economy May Now Avoid

The Fed’s move also has direct implications for your immediate portfolio strategy, and for the shape of the rally that’s likely to follow. The shift back to reflating the bubble – any bubble – means the game is afoot once again. The yen carry trade will no doubt swing back into action.

The U.S. economy is now likely to avoid recession, although housing will remain in its own private bear market, perhaps for several more years to come – just as tech shares (the previous burst-bubble class) have been laggards during the current bull market rise. The real action however is likely to be back in commodities and emerging markets, which should remain the asset class de jour!

In recent weeks, noticing potential breakout moves developing in several natural resource sectors, and in select emerging market leaders, I recommended a number of commodity-based plays as well as re-recommending a way to play the world’s fastest growing major economy.

Now that the Fed has given the green light to even more risk taking; it’s time for us all to sharpen our pencils and add to our buy lists! Of course it will all end badly… eventually. It always does. But it should be one heck of a blow-off rally in the meantime. You may as well play it for all it’s worth…

Hey, if you can’t beat them, you may as well join them… or at least profit off them!