How to Invest in a Market Constructed by Central Banks

How to Profit in a Fed-Built MarketThe resilience the stock market continues to have is a reflection of what continues to be extreme monetary stimulus. And while the stock market is a leading indicator and a bet on a future stream of earnings and economic activity, throughout history, the underlying goal of central banks has been price inflation.

Seemingly, the capitalist economic system is based on two basic underlying factors: property rights and price inflation. And in modern history, the latter, through central bank intervention, is the most important catalyst for the stock market.

In capital markets, long-run history is a very good guide and an important tool in helping to shape your market view. And most importantly, it’s very helpful in laying the groundwork for separating present-day conjecture from what has actually transpired before.

I’m reminded of J. Anthony Boeckh’s book titled The Great Reflation, which provides a non-political long-run analysis on the U.S. economy and its cycles.


It’s a historical breakdown of interest rates, inflation, and monetary and fiscal policies, and how they have affected the stock market. It is required reading for any serious long-term investor.

Written in 2010, the book breaks down financial crises and looks at the long-run effects of price inflation and the effects on capital markets. Boeckh offers some poignant analysis on all kinds of financial topics, and many of his observations have not only come to fruition, but they are also worth consideration.

Boeckh plainly states that the global financial system is flawed because of fiat paper money. And because we use paper money, price inflation exists and capital markets are subject to bubbles.

Add in a lack of financial discipline and restraint (on the part of all market participants, including central banks and policymakers), and paper money systems will inherently suffer price inflation and ongoing instability.

Boeckh’s view is that the U.S. economy is on the cusp of a new long-wave business cycle, set for 2015 and beyond. But he also says that capital markets will have to play a long game with the Federal Reserve getting out of this cycle of extreme monetary intervention. And it’s all related to excessive private and public debt.

Boeckh is an advocate of extreme policy intervention in order to help the private sector, but he acknowledges that for the most part, policy serves the institutions and the system itself, not the average person on Main Street.

The Great Reflation clearly demonstrates that stocks typically do well after major financial crises, but in today’s world, wealth preservation and portfolio safety are critical—which is something I’ve been saying for some time now.

According to Boeckh, the inflation-adjusted long-term uptrend in the stock market since 1929, including dividends, averages just less than seven percent annually. Over the long run, the S&P 500, deflated for inflation, is remarkably consistent.

So what should investors take from all of this? In a world where long-run history is repeating itself, investors need to perpetually rebalance their portfolios—to continually adjust your exposure to equities as inflationary and deflationary cycles are constructed by central banks. (See “The Only Place to Put New Money in Today’s Economy.”)