It's no secret that Ben Bernanke, the chairman of the Federal Reserve, has been manipulating markets for the last several years. More specifically, the Fed has been actively influencing prices of income-producing assets, with the stated purpose of "stimulating the economy."
The effectiveness of the Fed's actions has been debatable at best. The US's economic recovery has been slow and feeble. And if you look behind the headlines, you'll find that the term "recovery" is probably too generous to use.
The one area in which the Fed HAS been effective is in keeping interest rates extremely low. As I'll explain in a moment, the Fed has actively manipulated interest rates, which in turn affects the prices of a broad assortment of asset classes and investment opportunities.
If you are one of the millions of investors who count on regular income from your savings or investment portfolios, you have the Fed to thank for the difficulty you currently have in generating reliable dividends or interest payments. But today, we're on the cusp of a dramatic shift in policy...
This shift will have a material effect on your ability to produce income from your retirement account, from the savings you have carefully set aside, or from your traditional investment account. Investors who understand the dynamics behind this shift will be well positioned to capitalize on tremendous income opportunities.
On the other hand, those who are caught unaware could see their account balance stagnate – or worse yet, take a significant haircut.
Let me explain how the Fed's manipulation strategy works...
Forcing Investors to Take Risks
It may sound counterintuitive, but Ben Bernanke and the Federal Reserve want you to take on more investment risk...
Hi, I'm Suraj Tiwari My job in running this Blogg is to help investors like you invest in the very best income-producing opportunities available. There are a number of great companies that have stable businesses and that pay healthy dividends every quarter (and, in some cases, every month).
As a general rule, income investing is a relatively low-risk way to generate necessary cash flow from your investment portfolio, while protecting the underlying balance of your account. But over the past few years, Bernanke & Co. have made the business of income investing a bit more challenging.
Sure, there are DEFINITELY great income opportunities (and we are holding a number of strong dividend-paying stocks in our account right now). But today's income investor needs to use a little more finesse and discretion due to the Bernanke manipulation strategy.
You see, the Fed doesn't particularly like income investors... The Fed would rather you put your money in more speculative stocks – because it believes that if investors allocate their capital to companies that are more speculative, it will help the economy grow faster.
I'll save my outrage for another day... Let me just say that the Fed doesn't have a RIGHT to tell you or me where to invest our capital. And if growth opportunities are enticing enough to deserve capital from investors, growth stock investors will recognize the opportunity and naturally allocate their investment dollars to the right place!
Back to the Fed... At this point in time, the Fed is buying $85 billion worth of Treasury bonds and mortgage-backed securities per month. This bond purchase program has manipulated interest rates, causing them to sit at historic lows for several years now.
Income investors (including institutional investors such as pension plans, endowments, insurance company portfolios, etc.) have found it impossible to generate needed income because rates have been so low. So instead of buying bonds, many of these investors are moving capital "out on the risk curve" to dividend stocks. This is the only way that they can generate enough income to meet their obligations!
As more investment capital "reaches for yield" (or buys increasingly risky stocks in order to get dividend payments), dividend stocks have moved higher. With prices high, dividend investors have been forced to take more risk yet have received less income for every dollar invested. This is how the Fed is manipulating markets and forcing income investors to opt for more speculative stocks to invest in.
To be sure, the last few years have been very difficult for income investors. But all that is changing as we speak...
A Dramatic Shift in Policy
Last month, the environment for dividend stocks took a dramatic turn.
This shift happened when Ben Bernanke issued comments about the Fed's plans to "moderate" the bond purchase program over the next few months. At this point, it appears that the Fed will begin tapering the $85 billion monthly purchase program this fall, with the ultimate goal of shutting the program down entirely next year.
Ben's comments caught investors off guard. Up until this point, the Fed had been adamant that it would do "whatever it takes" to prop up the economy and keep interest rates low.
As traders anticipate the new shift in policy, interest rates are already beginning to rise. After all, if the Fed has now decided NOT to support the bond market with $85 billion per month, there is a strong likelihood that bond prices will fall and corresponding interest rates will rise. Already, we are seeing the highest mortgage rates since July 2011!
As interest rates rise, the effect is quickly spreading to dividend stocks. Remember, institutional investors who would normally be invested in bonds have moved out on the risk curve to buy dividend stocks. Now that rates are higher (and bonds are producing more income), these investors are starting to move capital back out of dividend-paying stocks.
The bottom line is that Bernanke's manipulation made for a difficult environment for dividend investors for several years. Now his comments are throwing the market into chaos as investors try to figure out what the Fed will do over the next few quarters.
You see, with the Fed no longer propping up bond prices, interest rates will be allowed to float toward more natural levels. This will cause the equilibrium between bond investors and dividend stock investors to level out to a more appropriate level.
