Nothing goes up forever. Not the Federal Reserve's balance sheet, not global debt levels, and not stock markets… even when governments don't shut down.
Precisely because the Fed's balance sheet ballooned from $869 billion in August 2007 to over $3.6 trillion (and counting) today, and in spite of ballooning U.S. and global debt levels, U.S. equity benchmarks have been inflated to precarious heights.
"Houston, we have a bubble."
While the sky-high Fed balance sheet and rising global debt levels are their own bubbles, when they diverge – meaning, when the Fed starts to taper as global debt inflates – look out.
If the Fed-induced pump priming of financial assets isn't backstopped by strong and real global GDP growth, the increasing debt burden of the world's citizens will act as the ultimate pinprick that explodes the United States' inflated financial assets bubble… and other global bubbles.
So here's what's really happening, how to prepare for the eventual correction (or possible crash), and – more importantly – how to make money from it…
Up to 40% of Your Gains Aren't Real
The credit crisis that crescendoed in the autumn of 2008 was called a "credit crisis" because banks stopped lending overnight to each other, and short-term financing markets effectively shut down. There was no credit.
The Fed had to intervene and aggressively lubricate seized-up liquidity conduits, not just for banks, but for insurance companies, money markets, and corporations. And not just here in the United States. The Fed facilitated massive global liquidity vis-à-vis currency swaps and other dollar liquidity mechanisms.
Since the Fed's primary constituents are America's biggest too-big-to-fail banks, and because America's biggest banks are all interconnected (see "The Mother of All Bubbles") with banking behemoths across the globe, the correlation exposure faced by the world's biggest banks required a concerted effort to save them all.
The Fed, having the biggest capacity to expand its balance sheet (given the de-facto backing of the U.S. government and American taxpayers), took the lead, and central banks around the globe stimulated with gusto.
Because the credit crisis morphed into the Great Recession, the Fed, in the face of a dysfunctional and denuded American Congress, continued a zero-interest-rate policy (on overnight and short-term loans) to flush banks with cash in an articulated "wealth effect" policy aimed to pump up financial assets.
The wealth effect is a project to elevate devastated pension and retirement funds and invigorate consumer confidence by virtue of a rising stock market.
By pushing investors out of low-yielding fixed-income assets and into equity assets, the Fed engineered a rising stock market. Record-low interest rates further invigorated the stock market, as corporations have been able to borrow cheaply in the bond market to mainly execute stock buyback programs, lifting their own shares and the market to boot.
According to some estimates, as much as 40% of the rise in stocks over the past three years can be directly attributed to share buybacks funded by bond-market borrowing.
We have the Fed to thank for all that. But now we have the problem that markets, drunk with the Fed's Kool-Aid, are facing the prospect of the punchbowl being removed.
And it's a very big "problem."
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.