What Does The Fed Know That We Don’t?

At the beginning of the year, the Fed was expected to increase interest rates in the midst of a booming economy. Now, just months later, it has reversed course, not just maintaining interest rates, but dropping them.

They seem to know something we don’t know. Or, perhaps, the writing is on the wall and we’re just refusing to read it. After all, China’s economy is slowing on account of its debt burden, aging population, and trade uncertainty, and its impact on the world economy certainly isn’t going to wane any time soon.   

There are mixed signals out of Europe, as Brexit appears headed to an October resolution, which should bring stability. But we can expect volatility in the interim as new Prime Minister Boris Johnson and EU leaders engage in a high-stakes game of “no deal” chicken. Further, European banks are still skittish about lending, and Deutsche bank, once a bellwether for European banking generally, has seen large books of business go to rivals.

While banking is stronger here in the United States, manufacturing, which has driven growth the last several years, has tapered off somewhat. Inventory is growing, resulting in declining factory orders. Deficit spending has compounded the unease amongst investors, as congress has all but ensured the debt ceiling will be raised in perpetuity.

On the other hand, you have investors assigning nine-figure valuations to companies like Uber and Lyft that aren’t even turning a profit. There is certainly a feeling that we are in the midst of the bubble, and many experts are predicting a recession sooner than later.

And then there is the curious case of the stocks and bond markets. Under ordinary circumstances, you would expect to see a flagging bond market in light of a surging stock market.

So who do you believe? Pundits may think valuations have gotten out of control, but the markets are assuredly incorporating the risk into the price. People are investing in stocks AND bonds because they expect to turn a profit from those investments. When it comes to our current economic situation, there are a few prevailing theories.

Modern Monetary Theory (MMT) has gained some traction in recent years. Essentially, it posits that, so long as a country controls the printing press, deficit spending can continue apace. 

It’s worth noting that, while our deficit spending is a concern, it trails other countries. Japan’s national debt to GDP ratio sits at 234%. That’s higher than Venezuela according to the 2019 data put out by the World Population Review. Many countries hover close to a 1:1 debt to GDP ratio similar to the United States’ 105% GDP ratio.

But is that sustainable? Japan has seen stagnant growth, though that has been driven by weak population growth. At a certain point, if you keep printing money, it won’t be worth the paper it is printed on. See: Venezuela.  

Conventional economic theory would suggest that there is another shoe to drop. Eventually, the stock market will crash. I’m not alone in comparing our present economic situation to the tech bubble of 1999. Wild-eyed valuations certainly contribute to that theory.  

In short, if MMT is correct, the stock and bond markets are simply reflecting economic reality, and rewarding spending. If conventional wisdom is right, something’s gotta’ give.  

There is a third theory, promoted by deficit hawks, that both markets are wrong, reflecting the illusion of wealth and unwarranted optimism. Inflation will offset recent gains, the theory holds, as the nation’s bills come due and international economic realities take hold.

Someone is right, and someone is wrong. The Fed certainly isn’t bullish. Someone knows something you (and I) don’t. So what do you do?

Counterintuitively, it isn’t necessarily important to know who is right, but rather that someone is wrong. If very smart money people cannot agree on where the markets are headed, all options need to be on the table.

You are probably familiar with the basics. You want some assets in stocks, some in bonds, and some in money markets. Over time, history demonstrates, you’ll likely see a return on your investments and mitigate risk.

But in these unprecedented times, asset diversification might require us to look beyond the basics. Hedge fund manager Ray Dalio has been banging the drum for gold for years, for example.

Investing in gold is often seen as a reactionary measure, a more dignified version of stuffing money in your pillow-case. But it might make some sense.

Gold prices have been rising but you could make the case it represents a strong value. And deficit spending is, historically, a precursor to inflation. Of course, gold isn’t the only asset untethered from the markets. Reinsurance might be a smart move for the hawkish investor.

Smart diversification trumps betting on experts any day. When it comes to your retirement, it’s more important to be prepared than right. After all, you don’t know what you don’t know, even if the Fed does.

Disclosures.

 

Source link

Share with your friends!

Products You May Like

Leave a Reply

Your email address will not be published. Required fields are marked *

Get The Latest Investing Tips
Straight to your inbox

Subscribe to our mailing list and get interesting stuff and updates to your email inbox.