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There have been many recent reports about those waiting for a market pull-back. After all, we have seen two strong months and some investment and hedge fund managers may feel under-invested as year end approaches. Those of us with new accounts have been looking for a good chance to buy, and feeling some frustration. Is now the time?

Individual investors have mostly been paralyzed with fear. The Age of the Internet has not served them well. The best stories, whether from mainstream media or blogs, are always about problems.

Today I would like to highlight two distinctly different approaches to thinking about your investments. One of these looks to stock fundamentals and earnings. The other focuses on headlines.

The Fundamentals

If you want to spend a very profitable five minutes, watch this screencast from Abnormal Returns.

I especially like host Tadas Viskanta explaining that this is a contrarian story. Tadas, who constructs his daily guide to the investment world after reading hundreds of articles, has a better take than anyone on the general tenor of commentary. I strongly recommend that readers check out the links in the story. I especially like the cited work of two of our featured sources --- why fundamentals make lousy TV and fourteen reasons that things are better than you think.

This is an especially good article because of the timing. It is easy to write something "explaining" the day's market action and attempting to appear brilliant. These stories comprise much of the guest list on financial TV. It takes more courage and adds more value to go against the grain.

The Distraction

The ongoing "big story" features the Fed and QE II. The story has all of the ingredients needed for feature treatment.

  • Simplistic reasoning. Since ordinary people do not understand central banking, fractional reserves, or money creation, it is easy to be a demagogue. The phrase, "The Fed is printing money" is powerful and defies refutation. For the average person, it signifies everything that is wrong.
  • Political posturing. It is easy to assemble a list of people who disagree with the Fed, including those from both extremes. This is often a sign that policymakers are doing something right, but in this case people are just piling on.
  • International intrigue. Foreign countries are criticizing us. President Obama has supposedly been weakened.

This has gotten so bad that the cartoon discussion on YouTube has a million hits. Amazing. I wonder how many viewers are investors.... The good news?

Anyone who can read and think can get an investment edge.

What more could we ask?

The Key Point: Separating what will happen from what should happen

I do not know whether QE II will "work." I am much more confident about what the Fed will do. Here are three fearless forecasts:

  1. The Fed will be completely unmoved by foreign criticism. This should be obvious.
  2. The Fed will not react to partisan criticism. This is also obvious. I suppose there will be some great theater in the next two years. Those who do not think we should have a central bank will make a big fuss in Congressional hearings.
  3. Those choosing to "fight the Fed" with their investments will be big losers.

So much for what will happen. For investment decisions, that is the most important part. But we all like to understand what is going on.

Turning to what should happen, I understand that many readers are curious about the reasoning behind QE II. I also know that the readership here is pretty sophisticated, including experienced investors and colleagues in the advisory business. If you really want to understand what is going on, here are three excellent articles from leading sources:

Paul Kasriel, economist with Northern Trust.

Every student who took Econ 101 and stayed awake during the lectures learned that the Federal Reserve has the power to create credit figuratively “out of thin air.” The A-students also learned that the commercial banking system, not individual banks, under the fractional-reserve system that we and every other developed economy has also has the power to figuratively create credit out of thin air if the Federal Reserve first provides the “seed” money to do so. This is not unique to the Federal Reserve and the U.S. commercial banking system. This holds wherever there are central banks and fractional-reserve commercial banking systems.

Mark Thoma, University of Oregon economist, and the leading source of economic "pointers." Read the entire article for a nice explanation of the policy options, with graphs.

Presently, the Fed cannot operate at the short end of the yield curve because the short-term rate the Fed generally targets –- the overnight federal funds rate — is at or very near zero. Operating at the short-end of the yield curve doesn’t do much good since those rates can’t come down any further. However, the Fed can still bring down rates at the long-end:

Yc4

And finally, former Dallas Fed President Bob McTeer. Of all the commentators, McTeer provides the most consistently accurate and pragmatic view.

I don’t quite get the logic of the “won’t-work-but-it-will-be- inflationary” point of view. If it won’t work to stimulate the economy, that presumably means it won’t stimulate spending. If that is so, how is it inflationary? If more bank reserve sit idle as excess reserves and aren’t used for lending, investing, and money creation, how is it supposed to tank the dollar? New (printed, if you insist) money must be spent on goods and services to drive their prices up; it must be spent on foreign exchange to drive the dollar down. If it isn’t spent, it doesn’t do good, or harm.

Say it won’t work. Or, say it will be inflationary. But don’t say both without explaining how that is supposed to work.

Conclusion

On the one hand, you can get your investment advice from cartoons and fight the Fed.

Or you can -- and should -- focus on fundamentals.

Source: Investment Outlook: Focusing on Fundamentals vs. the QE II Distraction