Double Dip, Anyone?

Federal Reserve Chairman Ben Bernanke said the Fed "will do all it can" to avert a recession and deflation. Bernanke then laid out the four things the Federal Reserve can do to support the economy.

1. First, the Fed can expand quantitative easing (QE). This would most likely come in the form of the Fed expanding its already bloated balance sheet even more.

2. Next, the Fed could extend the zero interest rate policy (ZIRP) even longer. The bond market already expects this to happen which is most likely a reason for the drop in yields this past month as the market is basically signaling there will be no rate cuts until 2014-2015.

3. The Federal Reserve could drop interest rates on reserves (IROR). Lowering this rate would be an attempt to get banks to lend again. I would note, though, that the rate is currently 0.25%. Cutting the IROR down by half or all the way down to zero most likely won't do much.

4. Finally, the Fed chairman notes the Fed could raise the official inflation target. The goal of this final maneuver would be to discourage banks from sitting on their cash.

These options are fine and Mr. Bernanke believes that these tools will help the US keep deflation at rest. In my opinion, the only real option Bernanke has is to keep printing dollars. But as Dr. Ed Yardeni of Yardeni research notes, Bernanke didn't mention this as an option at Jackson Hole.

Nevertheless, here's a quote from Bernanke's 2002 speech on deflation: "By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services."

Even though Bernanke didn't mention his printing press, I still think this is the most likely option and one that the equity markets truly enjoy. Professor Jon Markman did some research and he found that after the Bank of Japan (BOJ) started QE in 2001, the Nikkei went from 8,000 to 18,000. When the BOJ ended QE in 2008, the Nikkei declined all the way back to 8,000. Then here, the Fed started QE in 2009 and the S&P 500 went from 700 to 1,200; since the Fed stopped QE in March of this year, the S&P is down some 12%.

Even though the market has had a rough ride this year, some stocks are performing well, they just aren't conventional ones. A recent Wall Street Journal piece looked at "bunker stocks." The Journal found that companies that supply the essentials for a respectable fallout shelter were trading at or near 52-week highs. Some of the companies the journal featured were Dr. Pepper Snapple (DPS), Cummins (CMI), JM Smucker (SJM), and Hormel (HRL). These companies produce bottled water, canned food, and power generators.

I think more QE is right around the corner; the economy is weak and a double-dip is not a possibility, it's a reality. As Markman said, "I've seen estimates it could amount to as much as $1 trillion this time -- yes, that's with a T -- and do not doubt for a minute that it could happen."