What Is the Fed Balance Sheet?

The Fed balance sheet is the nearly $4.5 trillion in assets - from government bonds to mortgage-backed securities - the Fed bought between September 2008 and October 2014 as a way to stimulate the economy after the financial crisis.

Now, the Fed will unwind its balance sheet "relatively soon," according to Fed Chair Janet Yellen. However, Money Morning Technical Trading Specialist D.R. Barton, Jr., says selling those assets could create volatility in the stock market in coming months.

Starting in 2008, the U.S. Federal Reserve launched an asset-buying campaign to stabilize the economy during the financial crisis. The Fed initially bought over $1 trillion in assets in 2008, and it continued its policy of quantitative easing (buying assets to inject money into the economy) until October 2014, when its balance sheet reached $4.5 trillion.

You can see how the Fed's purchases tapered off by the end of 2014 in the chart below.

fed balance sheet

Now the Fed is planning to sell down its $4.5 trillion balance sheet, according to Yellen's congressional testimony this week (July 12). The Fed's trillion-dollar balance sheet can distort the market by taking these assets out of circulation and funneling investors into different, often riskier, investments.

According to Barton, this massive unwinding could lead to volatility in the stock market.

"This could have profound implications for the economy and markets," Barton said last Friday (July 7).

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Barton says the market's reactions to the Fed's asset sell-off will unleash "the kind of volatility we haven't seen in ages."

The CBOE Volatility Index - often called Wall Street's "fear gauge" - is currently sitting at 9.74, a five-year low, and it's down 66% from its 2016 high of 27.59. That means investors have been enjoying a calm market recently, and the Fed is about to make waves.

If Wall Street's "fear gauge" rises thanks to the Fed, some investors may panic - particularly after the Dow's recent tear, rising nearly 10% on the year to a current intraday high of 21,625 today.

But Barton says the Fed inducing volatility is actually "great news for traders."

Here's how Barton says investors can profit from the Fed's "big opportunity" when it sells off its assets...

How to Profit from the Fed Balance Sheet Unwinding

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Barton expects higher volatility will lead to stock prices dropping from their current highs. But for Barton, this is simply an opportunity to buy the best stocks at a discount.

"The volatility on the Nasdaq, in particular, is giving some of the best entry points in months on some of the best tech stocks," Barton said.

This sort of stock market volatility is normal - there have been four 10% pullbacks on the Dow during the current eight-year bull market run - but these pullbacks offer a way for investors to buy quality stocks at a discounted price, amplifying their profits.

Barton says investors who buy "any or all of the 'Fab Five' tech stocks" on a downturn will be glad they did. The "Fab Five" include Facebook Inc. (Nasdaq: FB), Amazon.com Inc. (Nasdaq: AMZN), Microsoft Corp. (Nasdaq: MSFT), Alphabet Inc. (Nasdaq: GOOGL), and Apple Inc. (Nasdaq: AAPL).

Look at what happened in August 2015, when the CBOE Volatility Index rocketed up from 13.49 on Aug. 13 to 40.74 on Aug. 25.


D.R. Barton, Jr., on a Tech Stock Buying Opportunity


MSFT stock fell 10% between Aug. 13 and the end of the month. An investor who bought Microsoft stock at $42.61 on Sept. 3 would have banked 29% profits by the end of October, as the stock rallied to $54.92 while the Volatility Index dropped back down to 14.54.

Investors who bought Alphabet on the dip would've been similarly rewarded.

Alphabet dropped 9% between Aug. 13 and Sept. 1, then it rallied 21% through the start of October.

That's just an example of how a jump in volatility can let you buy high-quality stocks at a discount and rake in double-digit profits. And while we don't know what higher volatility will do to tech stocks this time around, Wall Street analysts think they're heading up over the long term.

Analysts at Deutsche Bank Research forecast Alphabet stock could rise 28% over the next year, hitting $1,250 from its current share price of $975.01.

Morningstar Equity Research projects Microsoft's share price could jump 14% over the year, rising from $73.05 today to a potential share price of $83.

And if rising volatility sends these share prices dipping, your gains could be even more lucrative.

This strategy "fits in perfectly with our thesis that you want to buy quality, fundamentally strong stocks when the bears come out to stretch their legs," according to Barton.

The Bottom Line: The Fed's plan to unwind its $4.5 trillion balance sheet of assets could create volatility in the stock market. But investors should view price dips on the "Fab Five" tech stocks as buying opportunities because these stocks will go back up.

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