The Federal Reserve plays chicken with markets…and swerves

Most people think the Federal Reserve proactively sets economic policy. I believe the opposite is the case: that the Fed follows markets.

Proof for my view occurred yesterday. After years of preparing markets for a rise in interest rates and making it clear that September was the expected liftoff, the Fed decided not to raise interest rates on Thursday. Why? Because, I think, the Fed was reacting to market prices.

Of course, the Fed had their excuses all lined up: China’s volatile markets, Europe’s problematic economy, crashing commodity prices, etc. Yes, those were reasonable concerns, but I don’t think that was the Fed’s real reason.

You see, markets had already decided the Fed wasn’t going to raise rates. Market participants had looked at the data and come to the conclusion that the economy was too soft to raise rates. You can see this clearly in the remarks of savvy investors like Jeffrey Gundlach and banking executives like Goldman Sachs’ Lloyd Blankfein.

Markets had priced in no raise, and the Fed then caved to that reality. It was a game of chicken between markets and the Fed, and the Fed swerved into the ditch. If the Fed had pressed on with raising rates, markets would have reacted violently–having priced in no raise. Then, the Fed would have been on the hook for explaining why they caused markets to tumble.

You can see the Catch 22 the Fed finds itself in. On the one hand, they are supposed to “take away the punch bowl” when the economic party gets too crazy. On the other hand, if market participants don’t factor that removed punch bowl into market prices, then market crashes can be blamed on the Fed.

Under my way of thinking, the Federal Reserve will raise interest rates when markets expect it and have factored that into prices. If the Fed acts before then, they can and will be blamed for market volatility, a position no set of bureaucrats wants to find themselves in.

So, sit back and watch the Fed’s goings on with amusement. This circus is for the crowd, but it’s not important.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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The Federal Reserve plays chicken with markets…and swerves

New location at WordPress

After 8 1/2 years on Blogger, I moved to WordPress.

I will continue to post here on markets, the economy, financial planning and all things investing-related.

I look forward to hearing from you!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

New location at WordPress

Ray Dalio explains how the economy works

Perhaps a little over-simplified, but an excellent explanation of how the economy works by Ray Dalio.  

Credit is not created out of thin air, as he says, but by those willing to save instead of spend (except for demand deposit accounts, but that’s getting into details of how banks create credit apart from saving/investment, and still depends on people being willing to save/not spend).

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Ray Dalio explains how the economy works

Fee-only in name only

If you receive advice or asset management services, ask how you provider is compensated.

Some asset managers are compensated as a percentage of assets under management.  This is how most mutual funds work (and how I’m compensated).  This compensation is referred to as a fee.

Some asset managers are compensated by a flat fee.  They charge by the hour or a flat rate $500) for services provided.  This compensation is also clearly a fee.

Other financial planners or advisers are paid commissions.  In such arrangements, the professional is compensated when a transaction occurs.  For example, when you buy or sell a stock or bond, the stock broker gets a commission for the trade.  Or, when a financial planner recommends certain mutual funds, they receive a sales commission from the mutual fund (frequently as high as 5% of your money).  Or, when an insurance agent sells you life insurance or a variable annuity, they are paid a commission for the product they sell you.

Fees tend to be more transparent than commissions.  It’s very hard for advisers or managers to charge fees without clients knowing because they send a bill or the client has to write a check.

Commissions, however, are harder to see.  When a mutual fund pays a sales commission, the client may not even realize that such a fee has been paid.  Commissions must be disclosed, but you must read the fine print and it’s not as obvious as an invoice.

This distinction is not simply academic.  Advisers who claim to be fee-only are seen by many investors as more clearly and justly compensated, so many seek out “fee-only” advisers.

Shadier planners and advisers, however, have caught on to this designation and used it against clients.  It turns out many supposedly “fee-only” advisers are actually compensated with commissions.  See Jason Zweig’s article in the Wall Street Journal from last weekend.

Not surprisingly, many of these “fee-only” advisers work at brokerage houses.  Surprising to me, many carry the CFP or Certified Financial Planner designation.  So much for professionalism.  

If you don’t know how your planner or adviser is compensated, ask the question.  It may seem like an $800 fee for a plan is good money spent, that is until you find out your “planner” earned a $5,000 commission when you invested $100,000 in the mutual fund they suggested. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Fee-only in name only

Have corporate profit margins reached a permanently high plateau…doubtful

James Montier of Dresdner Kleinwort has another great article out.

In it, he takes Jeremy Siegel to task for his recent assertion that profit margins will not revert to the mean (go back to their average level of the past or below) and will stay at their current, record highs.

Jeremy Siegel is famous for being a professor at the esteemed University of Pennsylvania Wharton School of Business as well as being the well known author of Stocks for the Long Run.

Siegel’s argument is that U.S. based firms are deriving much more of their profits from fast-growing, overseas economies and that including private firms’ profits with public firms’ profits reduces the profit margins close to average.

Both of these arguments are suspect in Montier (and my) opinion.

As Jeremy Grantham puts it, if profit margins don’t mean revert (go back to average), then capitalism is broken. Competition will always drive aggregate profit margins down over time. This is an iron law of free market economics.

As for private plus public firms’ profit margins, the current margin of profits to Gross Domestic Product are at a 45 year high of 20%, far above the 16% average. Perhaps Siegel is looking at different numbers than Montier is.

Added to this, market history is littered with brilliant people who believe “it’s different this time.” As John Templeton put it, those are the four most dangerous words in investing.

A brilliant economist named Irving Fisher is famous for having said that stocks had hit a permanently high plateau in 1929. Unfortunately for Fisher’s reputation, the stock market proceeded to crash by over 90% over the following 3 years. Perhaps Siegel is hoping to supplant Fisher…

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.