Deciphering (and possibly Misinterpreting) Ben Bernanke

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Last Wednesday, market participants around the world turned to their television and computer screens to read the Federal Reserve’s press release about its recent committee meeting and listen to Ben Bernanke’s press conference. The press release was simple- nothing has changed. The Fed will continue its $85 billion in monthly purchases of Treasuries and mortgage-backed securities and the Fed Funds target rate will remain unchanged.

In his press conference, Bernanke noted that the US economy continues to recover but he reiterated his ongoing concern about the continued higher level of unemployment. He said the Fed would continue its different QE programs for now but he also tried to give the markets clearer guidance about when these programs might be wound down.

This scared the daylights out of a lot of people. The Dow Jones Industrial average closed down over 350 points on Thursday and took emerging markets, commodities, gold and even bonds along for the ride. Since then, the losses in all areas of the markets have extended somewhat. We think, for the most part, this is an overreaction.

For reference, the entire text of Bernanke’s comments can be found here:

Here is the section that has short term minded investors running for the hills:

“If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year; and if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear.”

Bernanke was trying to be more transparent with his comments and he certainly succeeded in raising the level of fear in the investment markets. Bernanke’s inner circle had some dissent on the matter. The St. Louis Federal Reserve Bank, led by James Bullard released some comments on Friday saying Bullard “… felt that the committee’s decision to authorize the chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed.” In other words, “shut up Ben.” It should be noted that Bullard is almost always the dissenting vote on the FOMC.

It’s interesting to see how Wall Street interprets the Fed’s comments and it seems a little difficult to understand the selloff especially when you see the additional comments Bernanke made:

“I would like to emphasize once more the point that our policy is in no way predetermined and will depend on the incoming data and the evolution of the outlook, as well as on the cumulative progress toward our objectives.”

Here is the best snippet:

“To use the analogy of driving an automobile, any slowing in the pace of purchases will be akin to letting up a bit on the gas pedal as the car picks up speed, not to beginning to apply the brakes.”

Bernanke is basically saying that the Fed will only pull back on its QE programs if the economy is showing additional signs of life. So the simple question is this: Isn’t this a good thing? An expanding economy means better prospects for future corporate profits. Yet, in its perverse wisdom, Wall Street looks like it’s trying to immediately price in the entire effect of ending all the QE programs now in place.

Additionally, don’t we all know these programs are not going to last forever? The near-term ending of QE, whether real or imagined, should not come as a shock to anyone.

The primary concern seems to be that the end of QE will mean higher interest rates and less money sloshing around in the system. Again, is this bad? We all know rates are artificially low and that they will go up at some point in the future but the Fed knows this as well. Does anyone really think they will simply let rates skyrocket? We view this as highly unlikely.

As near as we can tell, the QE programs have mostly been a psychological backstop to the markets but they have not really resulted in an actual excess of liquidity in the system. We find it difficult to see why more people don’t realize this. But then again, that would mean that the economy is actually growing basically of its own accord and that would mean all the doomsayers (and there are a lot of them out there) would need to admit they were wrong. This is something else we view as highly unlikely.

So, once again, the fear, greed and irrationality of Wall Street is affecting investment portfolios and we need to determine whether it is just random noise or if we should consider a change in our outlook. As the facts change, we need to be ready to change with them.

Where does this leave us with the markets? Is this a temporary pullback or the beginning of a bear market?

First, anyone who actually gives you an answer to this question has no idea what they are talking about. Nobody knows what the future is but marketers do know that people who go on TV and profess a specific outlook (right or wrong-nobody cares in 2 weeks) are perceived to know more than others and they garner more confidence which hopefully means people watching TV will buy their financial products. Never forget that the business of Wall Street is marketing, not investing.

What we do know is that trees do not grow to the sky and markets need to take a breather from time to time. So far, that’s what this selloff looks like to us. As we mentioned in prior commentaries, at some point in the year we are likely to see a loud and noisy correction. In the January 22 edition of Worth Considering we said: What else to possibly expect from the New Year? A scary market correction, of course! I wouldn’t anticipate that a normal, healthy correction at some point during the year would give way to a new downward trend across the board. Remember, corrections of 10-15% or so are what keep the longer term trend intact and keep dangerous excesses from building. There is no such thing as a calm correction. Not with “news” flowing as it does. But remember that while they aren’t calm, they are normal and healthy. They can come at any time and for nearly any reason. Try not to get swept up in the emotional aspects of them. And remember the insights of Peter Lynch who would rightly state that more money has been lost anticipating corrections than has ever been lost during them.

Remember that it’s not unusual to have a 5%+ pullback. Take a look at this chart from (click chart for a larger image)

Market-Corrections-5-Percent-or-GreaterThere’s no doubt that these pauses are painful as they occur. The cornerstone of successful long term investing is to not let the moments of pain deter you from your target of future growth and more purchasing power from your investments in the years ahead.

Beyond the US Stock Market

At present, we are seeing substantially more volatility from global markets than the US market. We are also seeing much more volatility in specific asset classes when compared to broad indexes. It’s been a difficult year to be a “diversified” investor. We’d seen US stocks up respectably earlier this year but nearly every single other asset class around the world has lagged far behind, and many of them negative. This has caused a drag in portfolios that aren’t 100% US stocks.

Does that mean we change our approach? Absolutely not! Over longer periods of time, a diversified portfolio has proven to have better returns with lower risk than a narrow, undiversified portfolio. Of course, when we see markets like our current one, we may question whether this is such a good approach. Unfortunately, a diversified approach almost never gives great instant results because it focuses more on lowering risk and preventing a permanent impairment of capital than immediate gratification.

Consider how the chart below shows the regular rotation out of the top and bottom spots each year but how an asset allocation approach tends to keep things more balanced. Again, this doesn’t assure a pain-free investment experience. But market volatility is the cost that must be paid to outperform the invisible thief of inflation.


Source: JP Morgan (click here)

Still, we cannot stick our heads in the sand and ignore the outside world. It is critical to stick with discipline. We need to likely expect additional volatility in the weeks and months ahead. While I don’t anticipate a new negative trend, it can’t be dismissed as a possibility.

The Takeaways:

• We are in a transition period that is being led by the bond market; this will likely lead to heightened volatility for the near future. As the chart above proves, this type of volatility is normal albeit uncomfortable.

• Stick with a disciplined and diversified investment approach. Again, in recent quarters this has not been rewarded since the US equity markets have been one of the globe’s truly rare bright spots. Chasing this (or any) one asset class isn’t likely to be a successful long term strategy. As the volatility clears in the future, expanding beyond the US markets will likely begin to be rewarded as it has been historically.

• Please don’t hesitate to contact us if you want to expand on these thoughts and how they might apply to you specifically. We are always here to help in any way possible.

Jeff Winn, Financial Services – Orlando FL

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