Risk/Reward Vol. 175
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"You think that I don't even mean a single word I say
It's only words/And words are all I have
To take your heart away."---lyrics from "Words" by the BeeGees
"We're caught in a trap/I can't walk out
Because I love you too much baby
Why can't you see/What you're doing to me---lyrics from "Suspicious Minds" sung by Elvis Presley
"It's your thing /Do what you wanna do
I can't tell you/Who to sock it to"---lyrics from "It's Your Thing" by the Isley Brothers
"It's only words" that Federal Reserve Chairman Ben Bernanke spoke on June 19th, but they "took the market's heart away." In what I believe to be a calculated moment of transparency, Bernanke stated that, should the economy continue to improve, the Federal Reserve's $85billion/month Treasury bond and mortgage purchase program known as QE3 would begin to taper this fall and would end as early as next June. Markets worldwide reacted immediately. Appreciating that the impact of QE3 has been to inflate prices across the risk spectrum (and in some instances such as junk bonds to create asset bubbles), frontrunners began to sell assets of all types (but most prominently U.S. Treasury Bonds) as soon as Bernanke uttered this definitive timetable. Within four trading days, Treasury bond prices plummeted as did the price of almost every financial asset around the globe. The Dow Jones Industrial Average (DJIA) dropped nearly 5%. (Recall that virtually all securities are priced in relation to the safest security in the world---the 10 Year US Treasury Bond; if it falls in price so does everything else---see vol. 172 www.riskrewardblog.blogspot.com ) This reaction was predictable unless Bernanke "didn't mean a single word he said."
Could it be that Bernanke and the Federal Reserve's Open Market Committee (FMOC), which administers QE3 and which authorized the statement, "did not see what they were doing to me (and the rest of the market)?" I think not. For the past several weeks every financial commentator has remarked that "we're caught in a (QE3) trap and can't walk out." That is, the markets "love QE3 too much, baby;" so much so that they rise on bad economic news and fall on good news because the former means that it is more likely that QE3 will continue. You think not? Then explain why the DJIA spiked 150 points on Wednesday on news that the gross domestic product grew only 1.8% instead of the previously reported 2.4%. In normal (not QE3 dominated) times the reaction to such disappointing news would be exactly the opposite. Moreover, Wednesday's rise was sandwiched between two thinly disguised attempts by the Fed to clarify Bernanke's timetable (both of which caused market gains) with two Fed governors stating on Tuesday and Thursday that the timing of any QE3 tapering should be driven by events, in particular a reduction in unemployment, and not by a calendar as suggested on June 19th by Uncle Ben. But, Friday saw the DJIA drop triple digits as Fed member Jeremy Stein muddied the waters further by stating that although any decision will be data driven, tapering could begin in September. If and how long QE3 lasts is the largest factor moving markets today---and as the above chronology demonstrates that revelation is not merely the product of my "Suspicious Mind." I believe the FOMC is purposefully sending mixed messages about QE3 tapering to wean the market from this dependence.
What should one do, trapped in a world so dominated by QE3? "It's your thing/Do what you wanna do. I can't tell you/ Who to sock it to". But I remain as uneasy as the markets themselves. One day the markets may tire of reacting to the FOMC's messaging at which time they will do "Their Own Thing." To me, the key indicator of this occurring will be the yield on the 10 Year Treasury Bond. If it stays at or below 2.5% for a sustained period it will indicate to me that the frontrunners are standing pat---at least for a while. If so, I likely will repurchase high yielding monthly dividend paying closed end funds to recapture some of the gains I lost during my short foray into "second level thinking." ( See Vol. 174 http://www.riskrewardblog.blogspot.com/ ). But even then, I will be prepared to exit should those yields rise above 2.5% (meaning the bond prices are falling). These past two weeks have given us a preview of how asset prices will deflate if and when Treasury bond prices begin to fall. I do not want to be holding stocks or bonds when they do.
Had I not been in cash, the triple digit daily volatility of the DJIA over the past two weeks would have caused me to "Twist and Shout" like an Isley Brother. And so, my profits and I remain on the sidelines, surveying the situation; all the while determined to "work it on out."
P.S. Thanks for all the warm congratulations on our 40th annivesary. I am a lucky man.
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