Will The FED Protect Your Wealth?

December 19, 2017

Will The FED Protect Your Wealth?

  • The wealth gap is growing. Invest like the rich.
  • The FED will be forced to protect stocks and real estate prices as they are the key to current economic growth.


The Boston Consulting Group interviews 250 investors annually who have a combined wealth of $500 billion. The results usually aren’t shocking except for this year. 65% of those investors think the market is overvalued.

Figure 1: Boston Consulting Group annual interview. Source: BCG.

This isn’t that surprising as the S&P 500 has gone up 19.55% year-to-date which is a huge performance. The question is whether the investors who invest in the S&P 500 now understand that the long term returns from investing will be around 4% in the best-case scenario or if they invest on the assumption that stocks will continue to go up and expect higher returns than 4% from the S&P 500 next year.

My suspicion is that most investors expect the S&P 500 to return at least 8%. This means that when the trend turns, there will be a lot of panic selling because any kind of return above 4% from the index is a speculative return which significantly increases the downside risks. But let’s see how the FED is positioning itself in relation to financial markets.

Figure 2: S&P 500 year to date. Source: CNN Money.

The FED’s Raising Of Interest Rates

If you read the FOMC statement, you’ll see that the current monetary policy is still accommodative which means that the perceived strength of the economy isn’t real, but fabricated through low interest rates and increased liquidity. Nevertheless, the FED is slowly increasing rates that will maybe lead to a more balanced market. I say maybe because there is a big chance that the FED won’t be able to significantly increase interest rates.

Stocks will continue to go up even with the FED tightening, but there is another investment vehicle, one used by those who were interviewed by the Boston Consulting Group, that is signaling interesting times ahead. The spread between the 10-year Treasury yield and the 2-year one is declining.

Figure 3: 10-year Treasury minus 2-year Treasury. Source: FRED.

A declining spread signals that there is a significant difference between what will happen in the short term and what will happen in the long term. The above figure shows how when the spread between the short term and long-term Treasuries gets close to or below zero, we can expect a recession following relatively quickly.

Those who look at long term returns are positioning themselves in 10-year bonds to take advantage of the current yields. This is because interest rates work like gravity on asset values, the higher the interest rates, the lower the value of stocks and bonds is due to the higher expected returns. However, there is a big chance that the FED will do whatever it takes to prevent any kind of declines in asset values because most of the wealth and current consumer confidence comes from increased paper wealth. It’s important to note that the wealth of Americans has tripled in the last 20 years.

Figure 4: Total wealth of Americans. Source: FRED.

However, it’s also important to mention that the increase in wealth hasn’t been equal.

If we look at the median wealth of Americans, it has just slightly increased over the last 30 years. Accounting for inflation, the median American is practically poorer than they were 30 years ago.

The more you get into the richer percentage of Americans, the bigger the growth is in wealth. The top 5% of Americans have increased their wealth 3 times, and the top 10% have seen the bulk of the increase in wealth of the total population. The divergence has primarily occurred in the last 10 years as the FED has intervened to save financial markets.

Figure 5: The median and mean household wealth. Source: Credit Suisse.

Going deeper into the matter and connecting it to interest rates, we can see that most of the confidence that pushes consumers to spend takes debt and consequently increases GDP and is due to higher net wealth which is purely the impact of low interest rates and an inflation in asset prices. Thus, the created wealth is just on paper. It isn’t real.

Figure 6: The increase in household wealth comes from higher stocks and real estate prices. Source: FED.

All of the above puts the FED in a very delicate situation. Higher interest rates push asset prices down and increase debt burdens. In an economy that is based on debt and fictive wealth, it really isn’t prudent to increase interest rates. Therefore, the conclusion is that we are either going to keep having low interest rates or we’ll have higher inflation.

In both cases, you should invest accordingly. Inflation protection should be the key component of your portfolio and don’t forget about debt. Not taking advantage of the current low interest rate environment and pat position central banks have put themselves in is something you will probably regret for the rest of your life.

© 2017 Investiv

By Sven Carlin FED FOMC Interest Rates Investiv Daily Share: