By Kelley Wright - Published June 2018
There has been a lot of hand wringing about what the Fed is going to do with interest rates. Why this is beats me as since late 2008, the Federal Reserve has been fairly transparent about their intentions, transmitting information and guidance through all available media sources. As such, there really hasn’t been any need to speculate on the Fed’s next move. To bolster this point below is a brief synopsis of Fed announcements:
I know, it’s a lot of dates bunched together, but it should be clear enough to make my point. Here’s the bottom line: In each instance the Fed told us what they were buying, how much they were buying, and when they were buying it. This is every institutional investor’s dream scenario, to know what and when the 800 lb. gorilla is going to do before they did it. Talk about easy money, wow.
What the timeline above represents in real terms however is liquidity - cash money injected directly into the markets. Now, what was the result of this liquidity injected into the stock and bond markets? Stock prices soared, as did bond prices, and the yields on fixed income were basically at or near zero. Now the Fed is telling us what they are selling, how much they are selling, and when they are selling it. In short, what the Fed giveth, the Fed taketh away. And, beginning in July the rate of withdrawal will increase to $70 billion per month. That’s $840 billion per year removed from the system PLUS the Fed just added another rate increase to four in 2018. If institutional investors profited from knowing when liquidity was being added to the system, one would guess they would equally profit from knowing when it was being withdrawn.
But wait, that’s assuming the conventional wisdom is correct that if the liquidity added after the financial crisis is withdrawn the market will decline in an equal manner that it advanced. That’s a little too neat and tidy in my opinion as neither you, nor I, or anyone else on this planet knows how this dynamic will play out.
The economy is obviously moving along at a healthy pace. Employment is strong and there are more job openings than there are bodies to fill them. Consumer and business confidence is high. The tax cuts appear to be a net positive and are adding liquidity to the system even as the Fed withdraws its accommodation. Take a quick glance at the Dividend Increase feature on page 17 and note all the highlighted increases, which represent an increase of at least 10%. Clearly corporations are using the tax cuts to increase the return to their shareholders. This is real money that can be used for current expenses or to reinvest into the market to compound returns.
To be sure all the extraordinary measures taken by the Fed and other central banks around the globe after the financial crisis were radical to say the least. And, in all fairness, these were experiments that no one knew would work or not. To be equally fair no one still knows whether they saved the economy and markets or simply delayed a day of reckoning for decades of fiscal and monetary abuse. Only after all the extraordinary measures and accommodations have been removed will we know for certain the efficacy of these experiments.
Clearly these are uncertainties. Uncertainties in the markets are not new however as uncertainties are part and parcel to investing. Uncertainties introduce risks into the markets, which is a requirement for return. It takes two competing sides to make a trade. A buyer risks that the asset he is purchasing is a greater value than his cash. The seller risks that the cash he is receiving is a greater value than his asset. Can both be right? Perhaps in the short-term, but in the long-term probably not.
These are not unimportant considerations, but they should not paralyze your investment activities. As value investors we have a roadmap to follow that remains constant even when uncertainties swirl around us: identify high-quality companies and recognize when they offer good value.
Fed policy, monetary and fiscal policy, geopolitical crisis, the list could go on and on, are always with us. This is the way of the world and times we live in. I wish there were a perfect scenario, a perfect environment, where all the planets and stars aligned into investing nirvana, but that is magical thinking. It’s never going to happen.
Look, if investing was easy everyone would be a genius investor. Of course, if it were easy there would be no returns. No folks, investing is a business and running a business requires work. As enlightened investors our business is research and analysis, finding great, high-quality companies and determining when they offer good value. And, if we conduct our business correctly, we will enjoy the fruits of our labor, which is consistent, long-term, real total return.
In closing, what we do is work, but just because it’s work doesn’t mean it can’t be fun. There’s nothing more fun than finding a great company that offers good value and buying before everyone else figures it out. Then it’s simply a matter of watching the stock progress from Undervalue, through its Rising Trend and eventually reaching Overvalue. Once the value has been fully expressed and realized at Overvalue you collect your capital gain along with all the dividends and dividend increases received since purchase as your just reward for exercising due diligence, patience and discipline. Call me crazy but that’s my idea of a good time.
ypically, summer can be a lazy time in the markets, but what with the early year correction that appears to be waning and working back to positive territory, it isn’t out of the question to have some more fireworks, in either direction. So, don’t be lazy and pay attention. You never know when and where Mr. Market will hand you a gift.
That is all, now soldier on.