There were a lot of great songs written in the 1980s but, with all respect to any Animotion fans out there, this one probably wasn’t one of them. Like a lot of ‘80s music it will stay with you, and to anyone who finds themselves accidentally singing “Obsession” on your way home tonight I certainly apologize. There is just no better way to describe the market’s fascination with central bank activity. Markets have always paid attention to central bankers but recently they seem to be truly obsessed, and it is not just with our Federal Reserve (Fed) but with any central bank – Europe, Japan, etc. The market has become hypersensitive to them all.
This seems somewhat strange to me because this obsession comes at a time when central bank power should really be questioned. After all, if what they do has so much control over the economy, then why isn’t the world experiencing the greatest economic rally of all time? It brings to mind another ‘80s classic which could be paraphrased like so, “This economy is so sluggish, there’s no tellin’ where the money went.”
We have never thought that so-called quantitative easing was the great evil that many pundits seem to think, but we also never thought it would work, and thus far we have been correct on both accounts. There is no evidence that real harm has been done. There are plenty of reasonable theories that suggest harm may be coming, but thus far the fact is that inflation has not spiked, the dollar has not become worthless, the earth has not stopped spinning, and we are not floating to our doom in outer space. Of course this realization will not keep eyes glued to a TV screen, so you are not likely to hear it from the financial pundits. However, this combination – no obvious harm and no success – is likely to encourage more of the same. The talk of the Fed pulling back is overblown in our opinion.
Of course today everyone is concerned about what happens when the Fed reverses course. The real fear mongers will put it like this, “What do you think will happen when the Fed has to sell all of those bonds they have been buying?” In fact in writing this article I googled quantitative easing and the first article that pulled up was from Time. The author, Paddy Hirsch, tells us that the Fed has purchased more than $2 trillion in Treasury bonds (this article is a year old so the number is much higher now), and he goes on to state, “At some point in the future it [the Fed] will have to sell all the bonds in bought.” Paddy and all the fear mongers go on to explain that when the Fed sells all of these bonds, interest rates will shoot to the sky, the cost of everything will skyrocket and our economy as we know it will cease to exist. It is all really scary and gripping stuff that probably sells a lot of magazines. Unfortunately it is built on a fallacy: The Fed does not, nor will it ever, “have” to sell a single bond.
When we give financial education sessions we always begin by saying that all investments can really be put in one of three categories: stocks, bonds or cash. Stocks are simply ownership in a business, and bonds are simply loans. Much of the time we can see the “sophisticated” audience members tuning out. Their expression usually says, “This is too simplified for me but it is great for my colleagues to hear.” The truth is that we all need to hear that message over and over again. On Tuesday of this week I gave a speech at a conference for advisers to the so-called ultra-high-net-worth marketplace. I was asked at least three questions from this very sophisticated audience, which suggested that the participants had forgotten what stocks and/or bonds really are. On Wednesday evening I was at an event for the CFA Society of Atlanta. Every single person in that room holds the most coveted credential in the financial world and in some form or fashion analyzes and/or manages various types of investment portfolios. There simply isn’t a more sophisticated investment audience, and multiple times I found myself in conversations where this simple truth seemed to be forgotten.
Bonds are loans and loans are paid back, or as we say in the financial world, they mature. The Fed, or any bond investor for that matter, can simply hold on to the bonds they own and eventually they will all mature and be no longer. Bondholders don’t ever have to sell. This doesn’t mean that the Fed may not decide to sell some of the bonds it has accumulated, but the idea that the purchasing must go in reverse is just plain wrong. Today the Fed is talking about easing off of the quantitative easing. In other words, they are talking (not doing, mind you, just talking) about buying slightly fewer bonds per month. Hardly Armageddon.
Stocks are ownership in a business. How will the Fed’s slow down (if they actually do it) of bond purchases impact stocks? It depends on the business. How will it impact your business? For most of us the answer is probably not at all. This does not mean that short-term traders won’t use it as an excuse, but these daily market gyrations only provide opportunities for those who are wise enough to remember what stocks and bonds really are and that investing in them is best done with a long-term mentality.
In the meantime, we are likely to hear more about this strange obsession. If you are a trader or a pundit the end-of-the-world story is, in the words of Robert Palmer, simply irresistible. That doesn’t make it true.
Chuck Osborne, CFA