October 8, 2010
By all accounts, this morning’s employment report of our economy shedding 95,000 non-farm payroll jobs was bad. But, as the fictional character Gordon Gekko told us in the movie Wall Street (the precursor to Money Never Sleeps), “Wall Street is the only place where perception is reality.” The perception is that the Federal Reserve will come to the rescue with another round of buying financial assets from the investment marketplace otherwise known as Quantitative Easing II (QE II). The other truism in the wonderful world of investments is “Don’t fight the Fed.”
The Fed is unequaled in its ability to move markets. This is one of those rare markets (since July of this year) where, thanks to the Fed boosting asset prices, stocks are doing better. Both commodities and bond prices are up. We usually do not get all of these asset classes moving in tandem. Usually bond prices drop because of inflationary fears, which will see commodities rise and stocks rise as well. Or, we see bonds rise in price and stocks drop along with commodity prices due to deflation. Right now the only thing that is giving up ground is the U.S. dollar as it falls relative to the Euro. This next round of QE II could end badly for one of these asset classes and we are betting against the bond market. The other item of interest is how this Fed easing is playing out in the emerging market economies. So many of them have their currency pegged to the U.S. dollar or the Euro that our easing becomes their easing. We like emerging markets, think BRIC (aka Brazil, Russia, India and China), and have a five percent stake in them.
Finally, the Fed is looking for inflation. The Fed would prefer inflation as opposed to deflation (for example Japan over the last twenty years). If you use ten year Treasury bonds versus ten year Treasury inflation-protected securities as an inflation gauge, this difference implies an inflation rate of 1.98%. The low for the year was 1.51% (The Financial Times, October 8, 2010). It looks like Mr. Bernanke will get his wish.
So, what does all this mean? We are at the start of companies reporting earnings for the third quarter. We think there will be positive upside surprises. Consequently we like big U.S. companies that pay and grow their dividends. We like emerging markets as their economies will be experiencing faster growth. We are keeping bond maturities very short (less than one year) except when we buy TIPS (Treasury inflation-protected securities). Our TIPS investments are in the 10 year area.
We think we are entering into what Keynes referred to as the Paradox of Thrift: consumer credit (think credit card balances) dropped $3.3 billion dollars in August and revolving credit dropped $5 billion dollars. We consumers are getting our financial income statements and balance sheets in order. We consumers are not spending like we used to and corporate America needs to adjust to that.
Enjoy the college football season.
JDM Investment Counsel, LLC
firstname.lastname@example.orgInformation contained herein has been obtained from sources believed to be reliable, but are not guaranteed. This article contains the opinions of the author and is subject to change without notice and is not a recommendation of any particular investment product or security.