The response by central banks to the 2008 crash has been unprecedented.
As you can see from the chart below, the Fed’s balance sheet has ballooned to more than $4 trillion – or about one-quarter of annual GDP.
Legendary investment manager Jeff Gundlach, of DoubleLine Capital, has an investment rule that every prudent investor should be aware of.
He calls it Gundlach’s Rule of Investment Risk.
It holds that efforts to limit economic volatility in the near-term don’t eliminate risk. Ultimately, the “fixes” end up causing much larger problems further down the line. As he explains:
If you run things and you try to get them very smooth, without ever any downside, you’re trying essentially to eliminate the frequency of problems. I believe the frequency of problems times the severity of problems when they occur equals a constant. Frequency times severity equals a constant. That is Gundlach’s Rule of Investment Risk. When you try unnaturally to push into the future problems, and quantitative easing is designed to do that, you end up increasing the severity of the problem.
In other words, you can have two scenarios: (1) frequent, yet shallow recessions or (2) infrequent, yet deeper recessions.
The Fed, the Bank of England, the Bank of Japan and the European Central Bank have all gone for option No. 1.
If Gundlach is right, that means a much more severe problem down the line.
Further Reading: Bonner & Partners senior analyst Braden Copeland has prepared a special report for investors worried about the next crash… and what to do when it comes. Braden details six stocks to buy and hold in the next panic. Find out what they are here.