Archive for the ‘The Federal Reserve Board’ Category

The Markets Need Psychotherapy

Monday, December 15th, 2014

“The whole idea that the stock market reflects fundamentals is, I think, wrong.  It really reflects psychology.  The aggregate stock market reflects psychology more than fundamentals.”

Robert Shiller, Nobel Prize-winning economist

Tired of low returns?  You may be a bond investor.

Bond investors have been “growing tired of low returns, the endless warnings that rates are about to rise, and constant reminders of the dangers of riskier bonds,” according to Jeffrey Matthias, CFA, CIPM of Madison Investment Advisors.

At the same time, they’ve watched the stock market continue to break new records every time there’s another sign that a central bank somewhere may buy a few bonds or lower interest rates into negative territory.

“None of us have ever lived through this kind of extreme, long-lasting suppressed rate environment,” Matthias wrote, and, as a result, those bond investors who are mad-as-hell-and-are-not-going-to-take-it-anymore have been frustrated enough to take on a lot more risk for a little more yield. Central Bank Assets

When you chase yield, you catch risk.  It’s a dangerous reaction to the yin and yang of investing – fear and greed.

“Typically, when markets are moving higher,” Matthias wrote, “most investors turn greedy and want more.  Should an investor’s more conservatively positioned portfolio produce lower returns when the market surges, the investor may regret not having taken more risk.  In contrast, should a riskier portfolio drop significantly in market value, the opposite may happen and an investor may begin to regret (his or her) decision to have invested in risker assets.  This can be accompanied by a fearful overreaction.”

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Sprinkling the Fairy Dust of Illusory Riches

Thursday, July 3rd, 2014

When the Bank for International Settlements (BIS) calls central bank market rigging “the fairy dust of illusory riches,” it’s time to pay attention.

The BIS is the central banks’ central bank.  Its role is “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.”

To provide the statement with some context, and to alert you about what else you can expect from central banks moving forward, we provide a summary of other key points made in this year’s BIS annual report, which is appropriately titled, “In Search of a New Compass.”Compass

First, there’s recognition that easy money policy has gone far enough.  That’s self-evident, but of special interest when you consider the source.  BIS notes that despite a pickup in economic growth, the world economy “has not shaken off its dependence on monetary stimulus.  Monetary policy is still struggling to normalize after so many years of extraordinary accommodation.”

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Prozac Nation

Friday, June 27th, 2014

It’s all stress-free bliss these days … at least for anyone who’s not paying attention.

Has someone been putting anti-depressants in the water supply?  That’s one way to explain Wednesday’s non-reaction to the report that the economy shrank by 2.9% in the first quarter – not the 1% drop previously reported.

It would also explain continued investor complacency reported last week, with the VIX (volatility index) approaching single digits.  And it would explain the plunge in junk bond yields to 5.6%, which is a full 3.4% points lower than the decade-long average of 9%.

GDP GrowthYet investors showed that they still have a pulse, when they took the Dow down 100 points after James Bullard, president of the St. Louis Federal Reserve, announced that an interest rate hike may take place in the first quarter of 2015.

So consider this in context.  In addition to the slumping economy, we have Russia’s continued takeover of Ukraine, which is now being overshadowed by the continued takeover of Iraq by Muslim terrorists known as ISIS and the possibility of U.S. military intervention.  We have civil war continuing in Syria and continued nuclear development in Iran, in spite of the lifting of sanctions.  We have U.S. veterans in need of medical treatment being ignored while the Veterans Administration fudges numbers.  We have the missing e-mails of Lois Lerner and six other IRS employees who allegedly targeted conservative groups.  We have continuing fallout in the healthcare industry from the pains of implementing Obamacare.  We have a stock market so overblown that price-to-earnings ratios are at levels higher than they’ve been through 89% of the history of the S&P 500.

So what’s moving the market?  A statement made by a Fed board member that repeats a statement he previously made.

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The Fed Goes Long

Friday, April 18th, 2014

Few investors today would consider investing in long-term Treasury bonds.

The yield curve, which measures the spread between interest rates for short-term and long-term bonds, is not as flat as it has been in recent years, but that’s faint hope for investors.

A 10-year Treasury is still yielding less than 3% interest.  If the Federal Reserve Board achieves its goal of pushing inflation up to 2%, the real interest on a 10-year bond purchased today will be under 1%, payable at maturity.yield-curve-investwithalex

If the Fed overshoots its goal and inflation moves higher, which is highly likely, a 10-year bond would produce a negative yield.  What’s the probability that inflation will remain lower that the current yield on a 10-year Treasury over that entire period?

The U.S. has not had a period when inflation remained below 3% for a 10-year period since the days of the Great Depression.  During the period of recession then slow growth that we’ve experienced since the financial crisis began in 2008, inflation has remained low and the Fed’s focus has been on fighting deflation.  But when the economy improves and normal growth returns, inflation is likely to move significantly higher, as higher inflation is a byproduct of a healthy economy.

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Good Market Rigging vs. Bad Market Rigging

Friday, April 4th, 2014

“The markets are rigged. … These firms make their money by front-running trades. They’re using their speed advantage to buy shares first and then selling them back at a higher price. The result is higher prices for investors in those shares. That’s rigged.”                                                                                                                                      Michael Lewis

Based on the Federal Reserve Board’s actions of the past five years, you may have thought that “market rigging” was a good thing.  After all, a great deal of wealth has been created from the Fed’s bond buying – although, granted, almost all of it went to those who were already wealthy.

But suddenly, high-frequency trading is being charged with rigging the markets and it’s creating a bit of a furor.  Apparently the Fed is responsible for good rigging and HFT is responsible for bad rigging.  Consider this week’s HFT-related news:

  • Michael Lewis, author of Moneyball, was interviewed by “60 Minutes” in advance of publication of his book, Flash Boys, in which he makes the case that HFT rigs the markets against the small investor.

  • There was the heavy backlash from those who disagree with his conclusion … that is, the people who make money off of high-frequency trading.  Supporters contend that HFT has created liquidity and reduced the cost of trading for small investors.  In other words, the market is rigged against small investors, but it costs them less to make a trade.  Yippee!!
  • Then there’s The Wall Street Journal’s announcement this week that HFT is being investigated by the FBI – not the Securities and Exchange Commission (although it is participating in the investigation), the FBI.  You know, the guys who investigate bank robberies, money laundering, drug cartels and the Mafia.  And now you can add high-frequency trading to that list.  Apparently, insider trading was already taken. (more…)

Bully for 2013 … But What About 2014?

Friday, January 3rd, 2014

2013 markets were full of bull.

The economy continued to sputter along, growing at about 2%, unemployment remained high and corporate profits were mediocre.  Yet the S&P 500 index rose a staggering 29.6%, its best performance since the go-go-days of 1997.

So what sort of bull drove this bull market?  The Federal Reserve Board’s quantitative easing (QE) program, high-frequency trading and exuberant investors who shifted into stocks with renewed confidence.

Investors Intelligence SurveyWhen Fed Chair Ben Bernanke hinted in May and June that The Fed might start pulling back on its bond buying soon, the market initially fell and interest rates rose.  But ironically, rising rates drove investors out of bonds and many invested further in stocks, pushing the market even higher.

More Bull in 2014?

As 2014 begins, the bullish sentiment continues.  More than 60% of those surveyed by Investors Intelligence are now bullish and the bull-bear ratio is at a record level of more than four.

Bullish sentiment at this level is typically a good thing, though, as high investor enthusiasm typically leads to a drop in the market.  When investors are at their most bullish, that’s when the stock market usually drops.

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Paper Taper

Friday, December 20th, 2013

So the taper begins in January.  Big deal.

That was the market’s initial reaction anyway.  In fact, the market viewed this week’s announcement as a positive, setting yet another record.  Conversely, when Fed Chairman Ben Bernanke first brought up the possibility of a taper in May, he sent the market reeling.  So talking about buying bonds has a greater impact than actually buying bonds.  Who knew?

Some believe the stock market rallied because The Fed made it clear that it will remain accommodative and that interest rates will remain near zero until the apocalypse.  That being the case, though, why did bond yields soar?  Go figure.Taper Impact

The taper announcement is not a big deal, though, because everyone knew it was coming – everyone except for the economists whose job it is to tell us when tapering is coming.  First they guessed wrong that it was coming in October, then they guessed wrong that it wasn’t coming in December.  Keep that in mind when you hear them tell you the economic benefits of more bond buying and more government spending.

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Define “Forever”

Friday, November 15th, 2013


In May, when Fed Chairman Ben Bernanke said that quantitative easing could not continue forever, the stock market tanked and the word “tapering” became the most feared word on Wall Street.

This past week, during her Congressional hearing as President Obama’s nominee to become the next chair of the Federal Reserve Board, Janet Yellen said, “QE cannot continue forever.”  The market moved higher.

Is it Ben morphing into Janet or Janet morphing into Ben?

Is it Ben morphing into Janet or Janet morphing into Ben?

Both the current Fed chair and his assumed successor assured us that the party’s not over, that there are still plenty of bonds to be bought.

But “forever” seems farther away now that it was back in May.

Ms. Yellen made it clear during her hearing that there’s still plenty of work for QE to do.  Citing high unemployment, she said, “It is important not to remove support, especially when the recovery is fragile and the tools available to monetary policy, should the economy falter, are limited.”

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At The Fed, Saying Trumps Doing

Tuesday, September 3rd, 2013

President Obama’s campaign slogan for last year’s election was “Forward.”  The Federal Reserve Board’s slogan in the coming months may be “forward guidance.”

According to Goldman Sachs, The Fed is expected to begin tapering its bond buying in September, but will place more of an emphasis on “forward guidance.”

So what exactly is “forward guidance?”  Here’s how The Fed defines it:Goldman 1

“Through ‘forward guidance,’ the Federal Open Market Committee provides an indication to households, businesses, and investors about the stance of monetary policy expected to prevail in the future.  By providing information about how long the Committee expects to keep the target for the federal funds rate exceptionally low, the forward guidance language can put downward pressure on longer-term interest rates and thereby lower the cost of credit for households and businesses, and also help improve broader financial conditions.”

In other words, it’s pontificating and predicting.

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The Off-On-Off Economy

Friday, August 9th, 2013

The economy recently has been full of stops and starts, ups and downs, good news and bad news.

Optimists will say that progress is being made, as we’ve moved beyond the all-bad-news days of 2007 and 2008.  Those of us who are less than optimistic would instead ask why it’s taken five years to get to the current dismal economic state.

Recovery always seems to be just around the next corner.  But the world is round and there is no next corner.

Zerohedge recently ran a series of 13 charts showing that any economic exuberance is irrational.  The charts compare the current “recovery” with four previous recoveries.  The trend lines in most cases are almost identical – except that the lines representing the current Keynesian-inspired recovery are well below the lines representing the previous four recoveries.  They show that:

  • Growth in gross domestic product is pitifully low.  If it were a patient, GDP would be signing up for hospice care.
  • The ISM Manufacturing Index has fallen significantly from two years ago.
  • Business inventories have risen significantly, signaling that new orders will likely drop.
  • Productivity is down, consumer spending is lackluster and housing starts, though improving, are nowhere near what they should be if the housing market were really recovering.

But cheer up … vehicle sales are up!  The recovery must be just around the next corner, wherever that is.

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