September 20, 2015 ZIRP

Risk/Reward Vol. 276

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

Although my sabbatical continues, I am compelled, once again, to reflect on what occurred. And this week was all about the decision by the Federal Reserve to stand pat on its zero interest rate policy (ZIRP). Although the decision was not a surprise, the rationale, as articulated by the Fed in its press statement and as expanded by Chair Yellen in her press conference, was.

Instead of focusing on employment and price stability which are the Fed’s mandates, the Chair spoke of many things including the Committee’s consideration of economic conditions in China and emerging markets, a strong dollar and volatility in the stock market. Since when are these the Fed’s concerns? Indeed, this lack of focus left markets worldwide wondering what developments, if any, will cause the Fed to raise rates. After all, unemployment is at 5% (which historically has been viewed as full employment) and the consumer price index (CPI) inflated (less food and energy) 1.8% year over year in August, a rate that approximates the Fed’s stated inflation goal of 2%. Moreover, GDP grew at a healthy 3.4% in the second quarter. So why not raise rates ?

Mr. Market abhors uncertainty, and the Fed’s trepidation in light of the above described data has made what was already
opaque monetary policymaking even murkier. What data point is going to improve so markedly between now and the end of the year so as to provide the Fed the assurance it needs to warrant a rate increase? I doubt any. So if the Fed does raise rates in December, it will be viewed as an arbitrary act, not one driven by data. This in turn will leave Mr. Market to wonder when and under what circumstances future increases will be implemented. It is not surprising that the Dow Jones Industrial Average and the S&P 500 fell 1.74% and 1.62% respectively on Friday.

On a personal level, my week was salvaged by real estate investment trusts (O and OHI) and preferred stocks (PGX and FFC), sectors which do well when the yield on the US 10 Year Treasury falls, as it did in the wake of the Fed’s announcement. That said, my appetite to add to any position has been lessened for the reasons discussed above.