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Illusionary Investing

Apr. 03, 2019 12:14 AM ET5 Comments


  • The Fed will get its chance to normalize (take higher) interest rates due to economic strength and price inflation as it shows up down the road.
  • It will play catch-up to new and surprising "data points."
  • As investors, we need to play the forward view and avoid the temptation to reposition based on short-term momentum, however palpable it feels at the time.

My career started in 1994, which was a stealth bear market for stocks and an outright bear market for bonds. Fed Chair Alan Greenspan hiked rates seven times as he played catch-up in response to a percolating economy that rediscovered its sea legs coming off the 1991 recession. The Federal Funds Rate doubled from 3.00% to 6.00%, and the 30-year bond yield jumped 150 basis points to 7.75%. You lost roughly 25% by owning the long bond, and although the S&P 500 grew operating earnings 18% that year, its price declined around 1.5%, while your average stock did far worse. This Fed era was quite opaque, often surprising the market and offering very little read-through. At times it seemed Greenspan reveled in non-transparency, as the opening quote reminds us.

The contrast today versus the Greenspan era is massive, both in Fed transparency and how the market attempts to reads its cues. The closed-door Fed of the ‘90s caused market participants to have to figure things out on their own, mandating a far more fundamental approach to capital allocation. This world of yesteryear cultivated an incredibly important factor in the market that is gravely missing today: risk-taking. Today there is precious little of it! We now have half of market participants agnostically owning passive vehicles, and another large group playing “risk-on/risk-off” by trading baskets of securities based on the illusion that they have been spoon-fed the right answers by the Federal Reserve’s teacher.

Consider the chart below, which shows the various Central Bank programs of “quantitative easing” (economic stimulation) and how the market volatility was squelched after these announced plans were put in place:

The “Fed to the rescue,” or the “Powell Put,” is alive and well. Ever since the Global Financial Crisis, the market has increasingly responded to Fed talk and the Fed has increasingly been

This article was written by

Smead Capital Management is a registered investment advisor headquartered in Seattle, WA; founded in 2007. The company was formed to allow investors to benefit from long-term ownership of common stocks meeting the firm’s eight proprietary investment criteria. The firm manages a US Large Cap equity strategy in separate accounts and a mutual fund for advisors, family offices and institutions.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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