Thursday, May 29, 2014

The Lucky, Lucky Fed

Soldiers want their generals to be lucky.  As capable and knowledgeable as generals may be, they still need luck to win.  And citizens want their central banks to be lucky, because central bankers often fail even if they are capable and knowledgeable.

The Federal Reserve has been very, very lucky.  Unrest in Ukraine, territorial disputes in East Asia, the usual morass in the Middle East, and now nationalist parties winning European elections, have all combined to push U.S. Treasury yields down even as the Fed steadily withdraws its quantitative easing.  Financial markets mavens who confidently predicted that this would be the year of rising interest rates and falling stock prices have had to substitute excuses and explanations for predictions. 

Some still persist in forecasting rising rates and falling stocks.  Perhaps they will be proven correct.  But if you're betting your money on these predictions, remember that you're, at least in part, betting on the Fed's luck running out.  A bet on bad luck is still a bet on luck.  If you wouldn't play the lottery or patronize a casino, why bet on (or against) the central bank's luck?  The smart thing to do is stay diversified, and be patient.  (See  The tortoise tends to be a better investor than the hare.

Friday, May 16, 2014

Why You Should Invest Like the Smart Money

One characteristic of the investing strategies of the wealthy is to diversify.  Stocks, bonds, money markets, real estate, alternative investments, collectibles, precious metals, jewelry, and so on are frequently found in the portfolios of the high net worth crowd.  Diversifying is a way to win no matter what's going on with asset values, and the wealthy want to stay wealthy.

The 99% should do no different, and recent market activity illustrates why.  Bond values have improbably risen in recent weeks, while stocks are stuck in a trading range right about where they started the year.  Gold and silver went up earlier this year, but have slid back.  Real estate ended 2013 with a roaring comeback, but now seems to have stalled out in many markets.  International markets have delinked, with Asian markets generally falling over the past six months, while European markets have moved up slightly (Ukraine crisis notwithstanding).  It would not have been easy to predict this mix of events.  Indeed, it's rare to find financial analysts who predict much of anything right.  Few predicted the 2007-08 financial crisis.  Few predicted the 30% jump in stocks in 2013.  Few predicted that bonds would rise this year.

The investing patterns of the smart money reveal that the smart move is to diversify.  Don't look for a quick buck.  You'll probably get a quick loss.  Don't look to hit a home run with a single investment.  The financial press may glamorize the few who manage to do that, but generally pays little attention to the many who fail.  Don't try to predict the unpredictable.  There are rare situations, like 2008-09, when all asset classes seem to be falling in value.  That's what can happen when vast amounts of debt and other leverage enter the financial system in one-sided bets dependent on rising asset values.  When that debt begins to lose value, the assets it was used to buy are at serious risk.  But more typical is what we have today--a lot of uncertainty, but some of the uncertainty is about the upside and some about the downside.  Most of the time, diversification is the best way to play your cards. 

And if you're still unhappy about your net worth, save more.  Whether the markets are doing well or badly, adding to your pool of capital will pay off in the long run.

Tuesday, May 6, 2014

Fed Guidance in a Fog

The terrain is getting foggier and foggier for the Federal Reserve.  Most recently, GDP barely grew (at an annual rate of 0.1% for the first quarter of 2014).  But nonfarm employment grew by 288,000 jobs in April, a pretty good pace.  And the unemployment rate dropped to 6.3%.  Not that many Fed Open Market Committee meetings ago, an unemployment level of 6.3% would have been below the point where the Fed's guidance dictated a rise in short term interest rates.  But rising rates would make the stock market pout and sulk.  So the Fed has backed away from firm benchmarks for monetary policy and is electrically sliding its way toward a strictly "data-based" policy.  What does that mean?  Apparently, it means whatever the Fed thinks the data indicates it should do in order to promote full employment. But if the data is becoming less clear, then what?

For more than a decade, the Fed has worked to provide greater transparency.  That's perceived to be a good thing because it tells the financial markets what to expect.  Presumably, investors will make wiser decisions if they better understand the lay of the land.  But transparency also encourages risk-taking.  If you know what the central bank will do, you can layer on more speculative bets because one factor that might blow you up now seems predictable.  This perhaps unintended consequence of transparency tends to lock the Fed into its guidance, and limit its options, because if you do something other than what you say, all the hedge funds, big banks and other speculators might get hosed.  And then the specter of a systemic tummy ache would loom. 

With the data getting murkier as the economy recovery sputters along, the Fed has become less transparent.  Most likely, this isn't accidental, as the Open Market Committee no doubt can see that the data is telling them less and less, and benchmarks don't mean what they used to mean.  The gamblers in the stock markets can't be happy, as the odds have become harder to calculate.  Fed policy now depends on the data, and recent data resembles a pushmi-pullyu.  

The Fed still hums the low interest rate melody even though it doesn't sing the lyrics any more.  That's a pretty good pacifier for the stock market, at least for now.  But with foreign affairs descending into the mosh pit (who wants to bet Vlad the Invader won't strike again?), and the economic recovery constantly shifting back and forth between first and second gears, the data--and consequently the Fed's guidance--will probably get foggier.