As regular readers of "A Dash" know, I have been monitoring debate about Fed policy for many years. There have been many confusing sources, including some bloggers who built their entire reputation on criticising the Fed. For 5 1/2 years I have suggested a different and profitable way of viewing the Fed:
- Analyze what the Fed will do, not what you think they should do.
- Don't confuse your political opinions with investing.
This approach makes it less fun to read my work, since we cannot all engage in some boo-yah comments about how dumb those guys in Washington really are. Meanwhile, if you focus on accurate prediction of policies, you can make clear-headed decisions about your investments.
For me -- and for my clients -- this is an easy and profitable choice.
A Summary of Known Fed Policy
Here is what we know about the Fed:
- They do not accept responsibility for commodity price increases. Various studies show that droughts, speculation, and other factors were responsible.
- They do not agree with the "man in the street" definitions of inflation. They like core inflation because of the predictive value. They don't care what your personal market basket shows.
- The Fed cannot control food and energy prices through interest rate policy. They know that, and you should, too.
- The Fed is still a bit more worried about deflation than inflation, and remains committed to low interest rates and QE II.
- The Fed wants some inflation -- about 2% by their own measures. They believe that a little inflation is good for the economy.
- The Fed does not fear a Congressional action against the dual mandate to consider employment and economic growth as well as inflation.
The mistaken emphasis on politics and economic theory -- what I call a false Fed fixation--- has caused many to miss a terrific rally in stocks. Those who have been completely wrong are compounding the error by engaging in even more political arguments. Enough! It is time to move on.
There is another viewpoint that I see as even more dangerous -- the idea that stocks have rallied only because of QE II. This is a lame excuse offered by those who have been totally wrong about the market fundamentals for many months.
There are some very simple and obvious facts:
- Expected corporate earnings have improved dramatically during the QE II period;
- Risk, as reflected in objective measures, has declined;
- Economic expectations, measured by objective third parties, have improved.
Some of this comes from the second order effects of Fed policy, but it is not a direct result of Fed action.
Those who do not understand the fundamental basis of the stock market rally are doomed to miss the next leg.
I know that a big Wall Street firm has a research report on QE II versus the fundamentals. Joe Wiesenthal at Business Insider, a long-time favorite source, accurately perceived this to be a big story. Please read Joe's article to get the complete background. You will find it compelling, and you will wonder why I disagree.
The story is important. The emphasis on the end of QE II is the big story for the next few months.
- Those who believe that no one will buy US treasuries after June should be held accountable.
- Those who confuse correlation with causation should be held accountable --- especially anyone with a PhD in Statistics.
We do not need to settle this right now. I hope to review the complete report in more detail, and others will as also. I expect an active and vibrant debate about the reasons for the six-month market rally, as well as the prospects for the next few months.
While I like to think that stock picking is important, I suspect that the focus on overall asset allocation will be even more significant.
My wonderful editor at SA always reminds me that articles are more interesting if there is actionable advice. Fair enough
I expect good earnings news, and appreciate the dips. For new accounts, and for those adding funds, we were buying some strong cyclical names like CAT, growth names like AAPL, and energy producers like NE -- as well as ETFs we have mentioned in prior articles.