Perhaps it's because the summer is over and people are a little unhappy about the shorter days and longer nights. Or maybe it's because the distraction of the lake, the beach or the links is over, prompting investors to turn their attention back to the markets.
Whatever it may be, September is known as the cruelest month for stocks, and so far at least, it has proven its mettle. Where things end up going forward remains to be seen, but what has become clear since summer's haze wore off is that the current investing environment is becoming increasingly difficult to navigate.
Indeed, with yield in fixed income having become minuscule, many investors are looking for alternative ways to both earn a half-decent return and, at the same time, protect themselves and their portfolios from increasing market volatility.
"Free money" refers to how central banks have set interest rates very low in the North America and at zero -- or in the negatives -- in many other countries. It costs practically nothing to borrow or invest -- hence the term "free money."
Interest rates in the developed world have not been this low in 5,000 years, and I cannot tell you how many individual and professional investors I have spoken with who are convinced interest rates will remain near zero forever.
We are now in a Bizarro world where continuing ultra-low interest rates are good for stocks, and talk of higher rates alone can send some markets reeling.
It's not too different than in the early 1980s when investors and most "experts" were convinced interest rates would remain in the high-teens and low-20 per cent range forever. Near-term bias dominates most peoples' views, which is to say that whatever has happened most recently is projected to the future.
"Free money" may seem positive, but it has caused many market distortions. Bond markets are in a bubble, and many stocks (especially large parts of the U.S. market) are very expensive, as earnings have not kept up with valuations and investors have put money in equities, especially high dividend paying ones, as they see no alternative. Don't even get me going about residential real estate in Vancouver and Toronto.
I was always led to believe that moderately rising interest rates signaled improving economic conditions as well as good equity markets, and declining interest rates meant deteriorating economic conditions and lower stock prices. We are now in a Bizarro world where continuing ultra-low interest rates are good for stocks, and talk of higher rates alone can send some markets reeling.
For value investors, such as ourselves, who have so far chosen to carry a higher-than-normal amount of cash, what is desperately needed is a broad market correction and/or an increase in corporate earnings. Earnings are basically in an "earnings recession" at the moment, meaning that we are seeing little to no growth in profits, and yet stock prices continue to rise thanks to "free money."
To me, it is looking a lot like 1999, when investors were only in the stock market because there was nowhere else to be, and didn't want to -- and frankly, couldn't -- miss out on the rally. Or so they thought.
San Francisco Federal Reserve Bank. (Photo: ED FREEMAN VIA GETTY IMAGES)
We believe that the current "free money" policies around the world of negative or zero-ish per cent central bank rates have not worked and do not work, and cannot understand why central banks continue to follow this course. The definition of insanity is doing the same thing over and over again and expecting a different result.
We think the Federal Reserve is well behind the curve and that interest rates should be higher -- and can't believe a 0.25 or 0.50 hike in rates will kill the U.S. economy. We don't know if the Fed will raise rates this year or next, but we do know it is necessary and long overdue. In the meantime, the bond market will do their work for them.
One way to protect yourself as an investor is to diversify and be prepared for several possible outcomes. For example, in addition to the value stocks we own, for most of our clients we have some short bonds, some 10-year bonds, some perpetual preferred shares and some rate reset preferreds -- rate reset preferreds will win if and when rates go up.
Of course, nobody knows for certain when rates will finally change their 30-plus year downtrend. We can only hope they do reverse course and start to modestly rise, as we believe the longer this current condition persists, the uglier the end could be.
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People commonly say that the Fed itself prints money. It's true that the Fed is in charge of the money supply. But technically, the Treasury Department prints money on the Fed's behalf. Asking the Treasury Department to print cash isn't even necessary for the Fed to buy securities.
Both CNN anchor Erin Burnett and Republican vice presidential nominee Paul Ryan have compared the Federal Reserve's quantitative easing to government spending. But the Federal Reserve actually has created new money by expanding its balance sheet. The Fed earned a $77.4 billion profit last year, most of which it gave to the U.S. government.
Some conservatives have claimed that the Federal Reserve is causing hyperinflation. But inflation is actually at historically low levels, and there is no sign that is going to change. Core prices have risen just 1.4 percent over the past year, according to the Labor Department -- below the Federal Reserve's target of 2 percent.
Some Federal Reserve critics claim that the Fed has devalued the U.S. dollar through a massive expansion of the amount of currency in circulation. But not only is inflation low; currency growth also has not really changed since the Fed started its stimulus measures, as noted by Business Insider's Joe Weisenthal.
Rep. Ron Paul (R-Tex.) has claimed that bringing back the gold standard would make prices more stable. But prices actually were much less stable under the gold standard than they are today, as The Atlantic's Matthew O'Brien and Business Insider's Joe Weisenthal have noted.
CNN anchor Erin Burnett claimed in September that the Federal Reserve's stimulus measures have caused food and gas prices to rise. But many economists believe global supply and demand issues are influencing these prices, not Fed policy. And there actually is no correlation between the Fed's stimulus measures and commodity prices, according to some economists Paul Krugman and Dean Baker.
Some Federal Reserve critics claim that the Fed's stimulus measures have destroyed jobs. But the Fed's quantitative easing measures actually have saved or created more than 2 million jobs, according to the Fed's economists. In addition, JPMorgan Chase chief economist Michael Feroli told Bloomberg last month that QE3 will provide at least a small benefit to the economy.
Rep. Paul Ryan (R-Wis.) has proposed tying the value of the U.S. dollar to a basket of commodities, in an aim to promote price stability. But this actually would cause prices to be much less stable and hurt the U.S. economy overall, as The Atlantic's Matthew O'Brien has noted.
Rep. Ron Paul (R-Tex.) claims that ending the Federal Reserve and returning to the gold standard would make the U.S. financial system more stable. But the U.S. economy actually experienced longer and more frequent financial crises and recessions during the 19th century, when the U.S. was using the gold standard and did not have the Fed.
Many commentators have claimed that there simply aren't any tools left in the Fed's toolkit to be able to help job growth. But some economists have noted that the Fed could target a higher inflation rate to stimulate job growth. The Fed, however, has ruled this option out -- for now.
Some commentators have claimed that the Fed can't safely unwind its quantitative easing measures. But the Fed's program involves buying some of the most heavily traded and owned securities in the world, Treasury and government-backed mortgage bonds. The Fed will likely have little problem finding buyers for these securities, all of which will eventually expire even if the Fed does nothing. But economists have noted that once the Fed decides it's time to unwind the stimulus, the economy will have improved to such an extent that this won't be an issue.
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