Risk/Reward Vol. 357
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Words have consequences when one is a central banker. Ask Ben Bernanke. Remember the "taper tantrum" of 2013 when he surprised the market by announcing a tapering of bond purchases without sufficient forewarning? Well, Janet Yellen remembers it and that is why she takes such pain to condition the market for any move of significance. For example, Mr. Market has been warned and fully expects the Fed to allow its balance sheet to run off at the rate of $10 to 50 billion per month starting this fall, to raise rates one more time this calendar year and to raise rates three times in 2018. Springing surprises is anathema to Chair Yellen. As she has stated on numerous occasions, she wants Fed actions to be as exciting as watching paint dry. This is a lesson that European Central Bank President Mario Draghi needs to learn. On Tuesday, out of the blue, he stated the following: "All the signs now point to a strengthening and broadening recovery in the euro area. Deflationary forces have been replaced by reflationary ones." What! Reflation has appeared nowhere in his previous comments. The reaction in the bond market was swift and significant as fixed income investors interpreted the statement to mean that the ECB would soon end its very accommodative 60billion Euro/month bond buying program. Since bond markets are more globalized than equity markets, the sell off hit everywhere including the United States. Yields (which move opposite to prices) shot through the roof. The yield on the all important US Ten Year Treasury Bond ("10Year") jumped from 2.14 to 2.3%, a huge move given the stability in rates below 2.2% that we have experienced recently. Predictably, the prices of those securities that are correlated to the 10Year fell.
So what did I, a man whose portfolio is closely pegged to the 10Year, do? First, I determined that despite the hit, my portfolio remained green. But even if it had dipped into the red, I would not have sold so long as the losses were less than 5%. Why not sell? Because over several years of tracking interest rates, I have learned that Mrs. Bond, like Mr. Market, often overreacts when surprises are sprung. And a quick review of the context in which Draghi's comment was made (reaffirming the monthly bond purchase program) confirmed the overreaction. So I bought more of the same, preferred stock and municipal bond closed end funds. If I am right, I should see nice capital gains and healthy monthly dividends from my new acquisitions.
The stock market, too, took a time out in the wake of Draghi's comments but came back strong by week's end. Seemingly each of the major indices flirts with a new record high on a daily basis despite periodic warnings that stock prices are bloated. This week's warning was a report that the CAPE (Nobel Prize winner Robert Shiller's comparative price/earnings chart) was near 30 for only the third time in its history. The other two were just before the stock market crashes of 1929 and 1999. Again, I say "So what". In a world dominated by central bank policies that depress interest rates, There Is No Alternative ("TINA") to stocks. In this regard, the House Financial Services Committee held hearings this week on "The Federal Reserve's Impact on Main Street, Retirees and Savings." The consensus of those that spoke was that the decade long easy money policies of the Federal Reserve have enriched the investor class at the expense of savers. Duh! One need not look beyond my 92 year old mother. At her age, traditional advice would have her in short term bonds and cd's. And that is where she is. As each matures she reinvests, often for below 2% returns. If her level of care increases she will erode principal. Should she be in stocks? Some would say yes, but what would a 10% or even a 2% correction do to her? No thank you. And she is not alone. One economist who testified at the hearing estimated that the past decade of centrally planned low interest rates has cost savers nearly $2.5 trillion in interest that in more normal times they could have expected. And to what end? As I have written ad nauseum in this blog, low interest rates have proven ineffective at spurring our economy which is growing at a pitiful 1.4% annually. No matter how low the rate, no one is going to buy what one does not need. People without children do not buy diapers, cribs, houses or minivans. And old people don't buy much at all. Look around. We are a childless, aging country. In other words, an economy with an ever shrinking number of buyers simply cannot grow no matter how accommodative its monetary policy. Finding ways to prosper in such an environment is the challenge we all face.
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