November 20, 2016 Fed Grip Ends

Risk/Reward Vol. 329

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

I am hunting this weekend.  But, I could not let the week pass without some comment.

Another week beyond the election and another flirtation with record highs for the major stock indices.  But to me the headline is "Fed Loses Grip on Mr. Market."  Ever since I started Risk/Reward (2010), THE dominant market force has been the Federal Reserve.  Harken back to the times leading up to and immediately after any Fed meeting or a Ben Bernanke/Janet Yellen speech.  Huge swings resulted.   Remember the Taper Tantrum in 2013 or more recently the 300 point swing in the Dow during Yellen's speech in April?  (see Vol. 302 http://www.riskrewardblog.blogspot.com/).  Her speech before Congress this week was a non event.   Moreover, the Fed's power has been perverse.  Contrary to how markets traditionally operate, for much of the past eight years bonds and stocks traded in unison, and good economic news caused equity prices to fall. (See Vol. 167)  Why?  Because the entire economic ecosystem became dependent upon ultra low interest rates. In the blink of an eye (or more accurately when PA went for Trump), that all changed.  Since election day, bonds have tanked while stocks have skyrocketed.  This is the natural order of things, Dear Readers.

I repeat, without any prompting from the Fed, investors have sold bonds and bought equities.  Why?  Because equities look inviting based upon fundamentals;  not because of cheap debt-induced stock buybacks.  For the first time in eight years, the repatriation of the trillions of dollars held overseas is a real possibility.  Tax reform is in the air.  And most importantly, the crushing burden of heavy regulation may end.  This latter point cannot be overemphasized.  Anyone who has run a business or advised those that do knows how heavy the yoke of regulation can be.  Having someone at the top who has chafed under that burden and is dedicated to relieving it is unprecedented in my lifetime. 

So will this cause me to recalibrate and become a buy and hold equity index investor?  No.  I applaud what is happening with these indices, but many of the headwinds of which I have written in the past (e.g. lower demand due to changing demographics) are still with us.  Moreover, the strengthening of the dollar (which we are now experiencing) presents as many challenges as it does opportunities.  My strategy remains the same:  wait for the bond bloodbath to quiet and then buy mispriced interest rate sensitive securities.  This approach has worked well for me in the past and is currently setting up nicely.