The One Commandment
Ben has come down from the mountain with the one commandment – take risk. All those at the base of the mountain, busy with such trivial pursuits as valuation, downside protection, relative value, and gosh forbid, the worst of all sins, have been told from on high to take risk.
Maybe that has been an exaggeration, but for the past month or more, the push from the Fed has never seemed greater. Stocks are hitting multi year highs, at close to setting new highs for the century, yet the Fed is still pushing investors into risk. Almost no one is “fighting the fed” as it is impossible to fight while holding hands and skipping through the tulips with the Chairman.
But what are they doing and what are the consequences?
I am not exactly sure what the Fed was originally supposed to do, I’m only marginally more aware of what they actually did for the better part of their history, but that has changed. They have become the arbiter of what people should do with their capital. I find it hard to believe that any one person should be in a position to determine the investments of a nation (and frankly the world) let alone one that has failed to address bubble after bubble. This particular chairman can only be accused of missing the sub-prime crisis and letting it get out of control. His predecessor was more directly responsible for that particular bubble (encouraging using short term borrowing) and had more than his fair share under his watch.
Yet, here we are, trying to figure out how to deal with this One Commandment.
Asset Price Growth versus Economic Growth
It would be easy if everyone followed the One Commandment. That CEO’s decided to build new plants to create new goods. That this commandment ensured customers would spend more so that new businesses could be created. But it seems that companies and individuals don’t follow this commandment as closely as financial markets do.
Rather than creating new business, we shift how business is done, who owns it, and who makes money from it. Rather than creating new things, we figure out creative ways to finance takeovers of existing things, creating a new risk reward dynamic, but little if any new wealth.
There is nothing wrong with that, it is in fact our jobs in the financial industry to do that, but it doesn’t mean it does anything for the economy.
Breaking the One Commandment
I remain bearish here. I have been punished for breaking the one commandment, but at least I’d had the sense to follow it well until recently. I’ve done a lot of “soul searching” this weekend and just can’t get on board with this current rally.
While I respect it, and am quite frankly scared by some of the moves we’ve seen in individual stocks, I can’t get on board. I will remain much smaller than I would and am looking to use options, because I do think the market could have a rather large move soon (and am willing to accept that the large move could be higher).
My reasons remain largely unchanged and are based on the premise that:
- Markets have priced in so much QE that it is easy for a pullback and any sense the Fed is also nervous about the monster Dr. Bernankenstein has created would be bad for risk assets
- The real economy continues to do only okay, and housing, while not getting worse, is a long way from being a big addition to growth
I continue to like Europe and Asia better than the U.S. and generally prefer Spain, Italy, and China to the larger countries.
Catch 22 and the Paradox of QE
We touched on this yesterday in the fixed income weekly, but think it is worth mentioning again.
The paradox is that one of the two assets the Fed is buying, treasuries, are the one asset class being sold by the market. So the market is rallying on Fed purchases, but chooses to sell the asset that the Fed is actually buying. I’m not saying it is nonsensical as higher growth should lead to higher yields, but at the same time, it does seem to lack a certain amount of logic. If the trade of selling treasuries turns out to be wrong, this incongruity will add to the punishment of those who bet against the Fed’s purchases.
The Catch 22 is that so many investors seem to relish the idea of a bond bubble. Long only stock pundits seem positively giddy at the expectation of a bond bubble. Yet this is a market, an economy, and a country that is barely surviving on low yields, how can we deal with higher yields?
- How does housing do in a bond bubble?
- How does our federal deficit look in a bond bubble?
- The bond market dwarfs the size of the stock market, so what percentage move would be required in equities to offset the wealth lost in bonds?
Be extremely careful what you wish for. I don’t think we get a bond bubble because I don’t see growth coming in fast enough, and Ben certainly realizes how important low yields are, and will do much to fight that, but if we get a bond bubble, I highly doubt domestic stocks will be a “safe haven”
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