November 15, 2014 Rock Steady

Risk/Reward Vol. 242

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

“Rock steady, baby/That’s what I feel now
Let’s call this song exactly what it is.”---lyrics from “Rock Steady” sung by Aretha Franklin

“I’m a lonely little petunia in an onion patch
In an onion patch/An onion patch.”---lyrics from “Lonely Little Petunia” sung by Arthur Godfrey

“The best is barely enough
But if that’s it/Then it will have to do.”---lyrics from “Barely Good Enough” sung by John Kay (of Steppenwolf fame)

With the Dow Jones Industrial Average gaining 61 points and the S&P 500 gaining 8 points this week, “let’s call this market exactly what it is/Rock steady, baby.” That said, “rock steady is not what I (or any other investor) feels now.” But why? Russia’s further incursion into Ukraine and the mishigas that is the Mideast notwithstanding, there is no immediate threat of war. Corporate profits, at least in the US, are acceptable if not spectacular. Interest rates remain low. In addition we are on the cusp of energy independence. Who would have believed that gasoline would be selling for under $3/gallon in 2014? So why the unease?

Perhaps it arises from the realization that the US economy is a “lonely little petunia in an onion patch/ The onion patch” that is the world’s economy. In advance of this weekend’s meeting in Brisbane of the world’s twenty largest economies (“G20”), Secretary of the Treasury, Jack Lew, expressed frustration and disappointment in the fiscal and monetary policies of Europe and China. He considers them too conservative and thus incapable of spurring growth. Although I rarely find myself aligned with the current administration, I do agree with Mr. Lew on one point: to wit, continued reliance on the American consumer to drive worldwide demand is not a formula for sustainable economic growth.

Nevertheless, the US stock market continues to set record highs. As stated ad nauseam here and elsewhere, the reason is obvious; there is no alternative. Simply put, U S equities are the best investment around. “That’s it/It will have to do.” Even if “ the best is barely enough.” Really, where else can one achieve any return on an investment? Evidencing this grim reality is a conversation that I had this week with a slightly older contemporary (age 67) who is in the process of selecting a wealth manager. In a recent interview with the most conservative institution in our city, the assembled investment team ( led by a 61 year old) told him that it would allocate NOTHING, not a dime, not a penny, into bonds or bond funds. The team had concluded that with interest rates so low (the benchmark 10 Year Treasury Bond closed Friday at 2.32%) the paltry returns available in bonds are not worth the risk of principal depreciation before maturity. What! What happened to the 60%/40% Rule? And then it struck me. Perhaps the fact that US equities are the only game in town is the real source of investor unease---as well it should be. Because when all of the money flows one way, bubbles ensue.

When the Federal Reserve adopted its zero-bound interest rate policy (ZIRP) in 2008, it did so with the intent of temporarily inflating asset (read, stock) prices knowing that in so doing it would discourage capital from being allocated into traditional “safe” investment vehicles such as money markets and bonds, those favored by retirees. No one foresaw that 6 years later ZIRP would still be the order of the day with no end in sight. Given our demographics and Japan’s 20 year experience with ZIRP, perhaps someone should have. But, no one did and so today, risk assets continue to soar while safe investments languish. This situation is not ideal for someone on the cusp of retirement. In the words of the great Aretha:

‘I ain't no psychiatrist
I ain't no doctor with degrees
But, it don't take too much I.Q.
To see what you're doin' to me”