The Storm Is on Its Way - Here's How You and Your Portfolio Can Weather It

Lee Adler

The LAMPP (Liquidity and Monetary Policy Profits) indicator is little changed this week. It's barely on yellow, perched precariously on the razor's edge of turning red.

But there is more than one storm headed our way that will knock our LAMPP into a bright, flashing crimson.

Not only do we have an excellent idea of how the U.S. Federal Reserve and the Treasury plan to impact the economy, but the hurricanes that are tearing through the country will have tremendous repercussions as well.

In fact, they could change everything.

Here's what you need to know to protect your portfolio from the coming storms...

We're About to Run Out of Gas

The LAMPP has two components.

One is the money that the Fed pumps into the pool of cash that fuels stock market rallies. The other is the amount of new Treasury supply coming into the market each week. When the Treasury issues new bonds, it pulls cash out of the financial markets. It competes with stocks for the available cash.

It's easiest to understand if you look at it like a gas station. The Fed fills the tank. The Treasury pumps gas out of the tank into its own tanks. It then uses that fuel to keep the U.S. economy running on all cylinders. Without that money, the economy would only run on three or four cylinders instead of six.

Now, primary dealers (the institutional investors and big hedge funds) also fill up at those gas stations. When the Treasury drains the tanks, there's less fuel left for the dealers and big traders. They can't buy as much stock. In addition, it costs them more to fill up their tanks because there's less fuel available to them. And the price of fuel rises.

If it's not clear by now, that fuel is cash. Its price is the cost of money - the interest rate.

Here's the problem...

The Treasury will start selling hundreds of billions in new Treasury bills, notes, and bonds as soon as Congress lifts the debt ceiling. It will drain most of the fuel from the station. There won't be as much left for dealers and hedge funds to buy stocks, and stock prices will begin to fall.

You can think of the LAMPP as the fuel gauge. Right now, it's telling us that there's barely enough fuel to keep the stock market engine running.

When the Treasury starts sucking out more of that fuel, there won't be enough to go around.

But the markets themselves are a source of fuel, and those dealers and speculators will turn to them to sell assets there to raise the cash they need to meet their obligations. Asset prices will fall.

Unfortunately, the Fed has put itself in a position that will only exacerbate the situation. It has promised to start siphoning cash from the market's tank very soon, with its plan to "normalize" its balance sheet.

Sources in close contact with the Fed have told us to expect that announcement in September, and the Fed usually begins to implement new policy in the first month after the FOMC announces it.

That means October - and the timing could not be worse.

Both the Fed and the Treasury will engage in actions in October that will take cash out of the tank that fuels rising stock prices. It will turn the LAMPP decisively red.

Let's break this recipe for disaster down...

Lee Adler

About the Author

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Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.

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