February 23, 2012 Sugar Pie

Risk/Reward Vol. 158

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

"Sugar Pie, Honey Bunch
You know that I love you
I can't help myself/I love you and nobody else."---lyrics from "I Can't Help Myself"sung by the Four Tops

"Sometimes there's no hope in/In chasing opium
I'd like to love you/But I'm not sure what's in your eyes
Mm, Shanghai surprise"---lyrics from "Shanghai Surprise" by George Harrison

"Well, I'm livin' in a foreign country/But I'm bound to cross the line...
"Come in " she said "I'll give you shelter from the storm."---lyrics from "Shelter from the Storm" by Bob Dylan

Back in December, the Federal Reserve announced the continuation and expansion of quantitative easing (QE) in the form of $40 billion of mortgage purchases and $45billion of Treasury securities purchases EACH MONTH until unemployment falls below 6.5% or until inflation becomes a concern. (See Vol 148 http://www.riskrewardblog.blogspot.com/ ) The stock market rose at the time in reaction to this "Sugar Pie, Honey Bunch"--which, in effect, is a guarantee by the Fed of cheap and plentiful credit until one of those benchmarks is achieved. The upward surge from this "I love you gesture" intensified when the Fiscal Cliff threat dissipated at year end. Since then the stock market "couldn't help itself" and has continued to rise---that is, until this Wednesday. On Wednesday, the Federal Reserve released the minutes of its January meeting at which many members expressed a new concern about the current QE program, even though unemployment still hovers near 8% and inflation is in check. This new concern arises from the belief that the prolonged period of low interest rates fostered by QE has resulted in an unhealthy credit bubble. This bubble has been exacerbated by investors such as pension plans, insurance companies and yours truly in search of yields greater than those available in investment grade securities. We, collectively, have been gobbling up riskier and riskier instruments such as junk bonds and senior loans as soon as they are marketed. (See last week's post) The result is an economy flush with cheap (and risky) debt; one susceptible to a hiccup that could cause a flood of credit defaults reminiscent of 2008. That said, the possibility that the Fed would halt cheap credit (upon which the stock market has come to rely) for a reason and on a timetable other than that articulated in December caused the Dow Jones Industrial Average (DJIA) to drop 108 points that day.

On Thursday, the Chinese Central Bank, facing its own bubble, ordered the removal of $146billion worth of credit from the Chinese banking system. That "Shanghai Surprise" caused the Chinese Composite Stock Index to fall 3%, its sharpest decline in 14 months. Clearly, Chinese stocks like their American counterparts have been buoyed by the "opium" of cheap credit. In reaction to that decline, the DJIA, which tracks many companies that "like to love" China, fell another 47 points.

Friday morning, James Bullard of the Fed gave assurance that the current version of QE will continue for quite some time. Assuaged, the DJIA rose 119 points closing up 19 points for the week. Keep your eyes and ears on Congress next Tuesday when Fed Chair Bernanke is scheduled to speak. Undoubtedly, the future of QE will be discussed, and what he says will impact the market.

Switching gears, two subscribers recently returned from the 7th Annual Inside ETF Conference held in Hollywood, Fla. where they hobnobbed with such investing luminaries as Mebane Faber and James Grant. At this stage in my life, this conference is a hotter ticket than a luxury box at the Super Bowl, and is a "can't miss" for me next year. Their take away was that it's time to "cross the line"---to become more internationally oriented and to embrace the "shelter from the storm" that investing in a "foreign county" may afford. Certainly, the 8.8% rise in the FTSE 100 (London) in the past 3 months and the 12% rise in the DAX (German stock market) in the past year, both of which went virtually unnoticed by me, are reasons enough to look overseas for better returns. Although my study as to where and how to best invest in foreign markets has just begun, I am encouraged by my 10% gain in the Japanese market ETF (DXJ) which I bought on January 9th.

In closing, remember that I enjoy hearing from each of you. Investing can test one's mettle, with this week's roller coaster being just one example. Please know that if your investing "life is filled with confusion/And (investing) happiness is just an illusion","Reach out for me" and like the Four Tops, "I'll be there."