A lesson from History: BAC, JPM, GS, VXX

October 27, 2010, 12:08 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

History has already proven when the government tries to influence the hands of the investment public bad things happen.  The most recent case was the bubble in the housing market.  The fear of recession after the Internet debacle caused interest rates to go down to abnormally low levels.  Everyone knows the end result.  With relaxed lending standards and low interest rates, loans were being given to anyone with a heartbeat, and now Bank of America (NYSE: BAC) is paying the price.  Obviously, the government wasn't the only one responsible, because we know JP Morgan (NYSE JPM) and Goldman Sachs (NYSE: GS) played a role and are also to blame, but the government surely influenced investors into the real estate market by keeping interest rates at abnormally low levels for extended periods of time.  That began the financial crisis.  What is different about today?

The main difference is the government cannot lower interest rates any further.  Using the only real tool they have for stimulating the economy, the Federal open market committee has already lowered interest rates to a point from which they can lower no further.  Having done so, they are trying to influence investment into the economy.  They are trying to influence loans, real estate purchases, and apparently investments into the stock market too.  Their decisions have been drafted, implemented, and always calculated.  Now, additional risks are on the horizon because their efforts have not helped the economy gain traction.

After lowering interest rates to a point of no return, the Federal open market committee is now threatening to infuse money into the system to support the economy.  These are uncharted waters, and Fed President Ben Bernanke has already said that he does not know what the consequences will be.  Not only does he not know what the consequences will be, but he has also stated clearly that he does not know what the potential positive effects of this quantitative easing measure will be either.  Therefore, he is taking steps to infuse money in the system without knowing what his effort will accomplish.

Reasonably, we all have an idea.  By infusing money into the system the government is trying to spur inflation.  Growth comes from two different sources, either companies grow organically by selling more products to more people, or they raise prices and increase revenues that way.  In turn, if more companies do this, GDP increases, and that is the goal of the FOMC, to keep the US out of recession and deflation.  In the current environment, companies have had a tough time increasing prices, and the big players in the market seemed to be outcompeting the smaller companies for market share, so although the overall corporate landscape is positive it is also highly competitive and rather restricted.

In the face of this scenario, the government is inflating commodity costs measurably.  It's calculated effort to lower the value of the dollar by printing money and engaging in policy upon which it does not know the outcome is in effect tightening the margins of corporate America, and the majority of the companies on Wall Street.  Expectedly, the largest companies will still outcompete the smaller ones, but with higher commodity costs and a difficulty passing costs on to consumers, the effort by the Federal open market committee to force GDP levels higher by inflating our way to prosperity is likely to turn out to have the exact opposite effect.

By tightening margins, the only positive thing in this economy, which has been large-cap corporate earnings, will be impaired.  In essence, by lowering the value of the dollar and increasing commodity prices the Federal open market committee is taking aim at the only positive attribute of the current economy.  It is doing so to force investment, at a time when the most accurate leading longer-term economic and stock market indicator in history tells us that new investments into our economy will decline precipitously until 2023.  THE INVESTMENT RATE

Investors whether it is in real estate, the stock market, bonds, private business, or any other asset class should recognize that the government is doing everything in its power to keep you from investing in safe assets.  That in itself is a telling sign.  The last time the government tried to influence investment the end result was a near collapse of our financial system.  This time, the result will likely be a collapse of much more than just that.  QE2 seems to be their last attempt.  If this fails, nothing will be left to support the economy as it continues to weaken within the third major down period in US History according to the Investment Rate.

Expect volatility levels to skyrocket.  Monitor the Volatility Index (NYSE: VXX) closely.  The government is engaging policy that inevitably will have a negative impact on our economy, be it now or later.

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