"Most of us can read the writing on the wall; we just assume it's addressed to someone else"
Ivern Ball
It has been a only few days since the event that might go down in history as a day "when Federal Reserve has finally acknowledged the existence of the former "Greenspan or now Bernanke put". By cutting rates by 75BP Fed has in effect told the investing world- "we will do whatever it takes to prevent a severe decline in the financial markets..." Whether it was a wise move is still open for debate, but one thing is clear to me personally- nominal stock price levels will be defended at all costs even if it requires "inflating" away the "real" savings.
I guess I was right to predict last Monday night, that the group of Fed governors was quite "weak in the knees" and thus was very likely to intervene with some kind of remedy to prevent another decline in the stock indices. And sure enough just 12 hours after my post, they cut rates abruptly :) While one might say it was a lucky coincidence, I think it wasn't at all surprising. What's more, this move was very typical of what we came to expect from the US Fed over the last twenty years- in the battle of fear and greed- Fed will always err on the side of greed, because battling fear is easy and makes them look smart in the short term, while battling greed is something "that Federal Reserve can not control" and is almost certain to cause some serious political pressures...
I remember how the surprise rate from Bernanke in August has for a short while forced me to question my understanding and logic of how the financial markets function in general and what role should Fed's play in the economy...
But after reading Greenspan's book my original views of benefits of less frequent interventions from the Fed have been reinforced and now more than ever I believe that US Fed has a lot to learn from ECB's Trichet... As far as Greenspans's legacy goes, even today I still have a lot of respect for him personally as well as for his deep understanding of the world economy. It is also true, that his ultra low, arguably unreasonably so, interest rate levels helped to trigger the real estate bubble... But it will be Bernanke's hasty rate cuts that are likely to determine whether US will go through a short term, mild recession or rather something more significant, something we have not seen since early 80s- a period of potentially anemic growth and stubbornly high inflation...
It is popular to say now that if Greenspan was at the helm of Federal Reserve today he would have dealt with it similarly to how Bernanke is responding. But I am not so sure -if you read his book carefully, he states clearly that situation surrounding us today is quite different from anything he had to ever deal with. The disinflationary influence of Chinese, Indian and former Soviet labor force entering the world economy has now diminished.
What's more, with the continued rapid wage inflation in these countries and rapid appreciation of "real asset" prices, these economies are now likely to cause just the opposite effect- more inflation. As Milton Friedman famously said-"Inflation always and everywhere is purely a monetary phenomenon"... Thus while it is quite simple to blame high food and oil prices for the latest inflation spike, it is simply a side effect of excess liquidity. And thus injecting more money into the economy in the face of the highest inflation level in 17 years is almost a "guaranteed" recipe for another bubble somewhere and in something...
Hence there lies an underlying opportunity. Where will this excess liquidity show up? I am going to watch the developments closely and will deliver my thoughts as they come in... :) For now, with mortgage rates closing on 5% and a potential refinancing surge only two more 25BP cuts away, Ben and Co might just succeed in slowing the declines of housing prices and potentially even lead to a short term revival of the financial sector, but the truth of the matter is simple- even if the nominal value of your house goes up, the real "inflation adjusted" value is likely to continue sliding lower. However, I am currently in the process of studying several closed end mortgage ETFs that are selling below NAV. If someone has ideas please feel free to send them over to me at skepticalcapitalist@gmail.com
But anyway, once again- enough rambling- back to stock picking. The main purpose of this blog should be helping investors make money, not arguing about Fed's actions... So here is a quick recap of what I have done last week- I sold my ultra short ETFs on Tuesday and jumped onto the long side the next day... I have bought a number my former "oversold" favorites- MGI, ETFC, GEOY, PTNR, CEL, HOLX, CTCM, RIG, CHNG. I still think that markets are likely to head lower in the next few months but with another potential rate cut in the works - this "dead cat bounce" rally might just keep us trading water in a narrow range of a 12000 +/- few hundred points for a short while...
I will do my final analysis and selection for the MSN contest this weekend, and will post my picks early next week But I still think that regardless of where the US markets head in the coming weeks- current prices for FXP (ultra short China) and EEV (ultra short emerging markets) now once again offer a good risk /reward trade off and represent a great hedge for almost any investor.
But as with any short positions- cap your losses to no more than 10% and take your gains on any double digit moves up :) You can't go broke taking profits :)
Stay safe,
Vad
www.skepticalcapitalist.com
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