Fed juiced stocks into tremendous rally, ex-Dallas head admits

The carnage thats taken place in the Chinese stock markets has been blamed in large part on its government policies to prop up and rig markets.

Its easy for Westerners to point fingers at the Chinese, but if what one former Federal Reserve policymaker recently said is true, the U.S. central banks post-crisis monetary engineering was just one big con game that artificially inflated the stock and bond markets.

What the Fed did, and I was part of that group, is we front-loaded a tremendous market rally starting in 2009, in March of 2009, ex-Dallas Fed chief Richard Fisher told CNBC on Tuesday. It was sort of what I call a reverse Wimpy factor: Give me two hamburgers today for one tomorrow. And Im not surprised that almost every single index you could look at, if you take away dividends in the S&P last year, unweighted goes down significantly. And all the other indices were down. In terms of the 10-year bond, there was almost no movement for the year.

Painful digestive period ahead: According to Fisher, the pain that U.S. markets are experiencing is not because of Chinas slowing economy and stock crash, but the withdrawal of Fed stimulus, which now is bringing on a major hangover. Basically, we had a tremendous rally and I think theres a great digestive period thats likely to take place now, and it may continue, because again, we front-loaded at the Federal Reserve an enormous rally in order to accomplish a wealth effect, he noted. So again, I wouldnt be surprised at whats happening. I wouldnt blame it on China; were always looking for excuses.

Overpriced market can correct: Fisher warned that the stock markets are overpriced and overdue for a correction, noting that numerous other analysts on CNBC have made the same observation. I was warning my colleagues, Dont go wobbly if we have a 10% to 20% correction at some point. The markets still overpriced. Everybody you talked to all morning long, from (Blackstone executive) Byron (Wien) on, have been warning that these markets are heavily priced. Were trading at 19 times earnings, were not having the kind of top-line growth we would like to have, were late in the cycle, things are richly priced. Theyre not cheap. They may not be overpriced any longer, but theyre certainly not cheap.

Investing pros are cautious: According to Fisher, who during his time at the Fed made headlines for owning the largest gold stake among his colleagues, he is seeing a lot of cautious positioning now among investment professionals. All of the managers that I talk to in my role at Barclays a lot of people are building cash positions. The long-only investors are being extremely cautious here. They raising their cash levels, are nervous about the valuations in the market. I could see significant downside; I could also see just a flat market for quite some time, again, digesting that enormous return the Fed engineered for almost six years.

Managers are turning to cash in order to prepare to buy assets cheaply if further crashes materialize. Moreover, cash is one of the only major asset classes that didnt sink in 2015. The only thing that really returned anything last year, again if you take away dividends, believe it or not was cash, at 0.1%. Thats a very unusual circumstance, he said.

Fed is now out of ammo: With the Fed now apparently tightening monetary policy and raising rates, true economic fundamentals will hold sway, and the results wont be pretty for many stocks that grew mainly because of central-bank infusions. The Federal Reserve is a giant weapon that has no ammunition left. What I do worry about is that it was the Fed, the Fed, the Fed. For half of my tenure, which was a decade there, everybody was looking for the Fed to float all boats. In my opinion, they got lazy. Now we go back to fundamental analysis, the kind of work that used to be done analyzing whether or not a company truly on its own is going to grow its bottom line and grow its shareholder value and price accordingly, and not just expect the tide to lift all boats. We are going to find out indeed, when the tide lifts, whos wearing a bathing seat and whos not. Markets should be working on their own animal spirits, but they were juiced up by the central banks, including the Federal Reserve.

While stocks still have to endure a stiff correction to return to their natural equilibrium, precious metals began their corrective slide in 2011 and have seemingly bottomed, with gold refusing to fall below $1,050. Now is the time to reallocate portfolios, shifting investment capital from overvalued stocks and into gold and silver before the latter resume their long-overdue ascent.

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