I guess that counts as a fat reed.
Yesterday at 4:30 p.m. ET—just a minute after I posted my piece on thin reeds that argued that the U.S. economy was growing more strongly than many investors expected https://jubakpicks.com/2010/02/18/my-thin-reeds-say-the-first-half-of-2010-will-be-surprisingly-strong-in-the-u-s/ —the U.S. Federal Reserve raised its discount rate by 0.25 percentage points to 0.75%.
The discount rate is the interest rate the Fed charges banks to borrow funds. The Federal Reserve also went back to its normal policy of limiting such borrowing to a maximum term of overnight. During the financial crisis the Fed had increased the term of such loans to a maximum of 30 days.
The move indicates that the Fed believes that the U.S. economy is growing strongly enough for it to take this small step back towards business as usual. In that the move adds to the evidence that I cited yesterday for stronger-than-expected economic growth over the next quarter or two.
However, this is a very limited move.
The Fed left its benchmark Fed funds rate at 0% to 0.25% and went out of its way to stress that this didn’t mark any change in its read on the state of the economy or in monetary policy.
I interpret that as the Fed’s way of saying the economy isn’t so strong that it’s about to raise interest rates across the board but things are good enough to unwind one of its emergency policies.
The increase in the discount rate is also important in the light of internal politics at the Federal Reserve. Recently a small but growing minority of voices at the Fed have begun to argue publicly that the Fed should be moving faster to reduce its balance sheet and to remove itself from the financial markets. I think Chairman Ben Bernanke would like to keep dissent from rising further—like his predecessor Alan Greenspan he seems to prize consensus. And this move, small as it is, is an indication that the Fed’s majority has heard the dissent.
Early reaction from the world’s financial markets has been predictable. The U.S. dollar climbed against 14 of 16 major currencies in trading in London (as of noon London time). The S&P 500 futures indicate that stocks will open lower this morning. That wouldn’t be unusual on any Friday that followed three days of gains. Traders typically take profits before a weekend, especially when global financial markets are so full of surprises.
The Fed’s move does suggest that further signs of strength in the economy will lead to other moves that will reduce stock market gains. If the economy strengthens and the Fed raises rates, the interest rate increase is likely to erase some of the potential for stock price appreciation.
The language of yesterday’s announcement says that collectors of thin reeds might still be a few months ahead of the Fed but that the Fed is starting to close the gap on economic expectations.
After listening to all the good comments I would like to add a couple of questions/suggestions.
Rising inflation in the 70’s made it harder for companies to make profits so P/E ratios fell on slow growth. We got better entry points and expectations weren’t so high. I think this resulted in higher dividend payouts and protected portfolio values. The trick today, in my opinion, will be to have cash to invest So if there is a drop to DOW 5000 we can jump in. There were many rallies that might have been taken advantage of also.
Although I don’t think they were around in the 70’s, am I right about MLP’s distributions?
I found out in Orlando recently that many MLP’s have a CPI plus 1.3% yearly increase in fees in their contracts. This would mean that their dividends, or distributions, could keep up with inflation and if so provide an income stream to reinvest at very good levels. And the ETN, AMJ relieves the tax complications and can be held in an IRA without worry. Just a thought.
KFed,
True inflation doesn’t discriminate. When specific areas such as health care costs go up due to demand, that is a different thing than inflation. Inflation is about an increase in the number of dollars entering the economy, thereby increasing the number of dollars chasing goods (and commodities).
tostoryteller,
Your investment views are similar to mine.
Tostoryteller…
Your points are well taken, particularly #4, however, I’m a wee bit confused as to #5. If a stock hits its “target” price, we don’t sell because???
EdMcGon…as always, thank you for taking the extra effort to answer my myriad of questions! By the way, I read where AOD is going to pay .12 per share for the next 3 months. I’m very pleased with the news
Thoughts about investing. My take for what it’s worth.
1. To me it means all of us will need to become exceptionally good stock pickers (with Jim’s help of course). Index funds make absolutely no sense to me in this environment unless they are targeting an area like Brazil – even then, I think you need to be careful.
2. Finding companies that consistently grow dividends with a business model aimed at market with underlying growth make sense to me (like a TEVA-like stock on price dips).
3. We’ll all be driven to more homework to flush out companies with growth opportunities that will counter an overall secular bear market trend.
4. I think for those of us investing with a time horizon of ten years or less, it will mean taking more risk with a smaller portion of your overall investment portfolio and being very conservative with the remainder.
5. In this environment I think it makes sense to not fall in love with your own ideas and sell equities into surges when they hit targets and then wait to either reinvest or find an even better risk/reward opportunity.
I truly enjoy the forum Jim has provided to provoke thought in a time when nothing feels quite right.
IMO, I think we will have inflation, but I think it will not be the likes of commodities. I think that is more of an inflationary thing for the developing country as they become more wealthy and are now able to build out their needs. For us (US), historically baby boomers needs are the cause for inflation from baby diapers, to cars, to house and now to health care. I read some where that majority of the wealth of our nation is amassed by the baby boomers and they are getting old. A factor of being old is requiring less necessity (e.g. I am find with the car that I have for the last 10 ten years and can last another ten). As such, I think commodities may become less of an inflationary factor in the US (IMO). What I think will be more of a bigger inflationary factor in the US is health care as the baby boomers will need more of it. I think the politics are realizing this and are making a big political debate over it.
So what does this mean. Yes, there is money to be made on commodities because BRIC countries need them. From an expenditure perspective, the bigger inflationary problem for us (i.e US) all is health care.
One more thought, if I am right about much of the wealth of our nation is amassed by the baby boomers and as they reach retiring age, I am guessing that they probably will move their retirement to safer asset. If that implies US bonds and treasury then perhaps the government may not have a big problem with borrowing money and inflation. It will be interesting to see if this holds true or not. A negative effect of this though is that baby boomers will move money away from their stock investment. If that does happens then the US stock market is going to be stuck in neutral or move up at a very slow rate…Food for thoughts and conspiracy thinking here, may be that is why the government is pushing very hard to get the younger generation to stuff money in 401k and privatizing Social Security.
KFED
What the fed did yesterday is quite significant here. First of all, the fed has announced that the we are now coming out of the financial crisis that began in 2007. So this is a near term bullish thing. However, this also starts the clock in that from here on, the fed is focusing on maintaining or increasing interest rate. At some point the increasing rate will become non-stimulative. That point will be some where around 3% (IMO here). We are now at .25% and so that is quite a way to go. This means that the long term investor has from now till that point to play with and start thinking about different strategy once that point hits.
Now what to do as interest goes north of that point as it has done in the past. It all depends whether the fed is on the offense (i.e. raising rate to cool off growth) or on the defense (i.e. raising rate to defend the dollar). If the fed is on the offense then the US and perhaps the global market is healthy then that is good for us all until the bubble burst (and here we go again). If the fed is on the defense then my investment will tilted more toward developing market as the defensive posture is clearing indicating that growth is else where and that else where right now is BRIC. At some point, that buble will burst to and here we go again.
Thanks Jim and all for sharing your insight and opinion. I very much appreciate them!
STL,
If there was one “magic bullet” solution, we’d all be praying for high inflation to take advantage of it!
Commodity investments are a good way to keep up with inflation (i.e. protect the value of the dollar you already have). To beat inflation, stay out of low-yielding investments, such as treasuries. Also avoid investments that tie up your money for long periods of time (even more reason to avoid CD’s!). For example, let’s say you buy a bond that pays 10% annually, but you have to hold it for 5 years. Sounds great, unless inflation goes up to 11%, in which case you are now losing 1% every year.
In other words, keep your money flexible in high inflation.
Having said that, there is no guaranty that we are seeing inflation, let alone high inflation. But keep your eyes open to the possibility. You’ll see it in your everyday life before any government reports come out and proclaim it. When you find that your monthly budget has gotten more expensive overall (and I mean the routine expenses, from groceries to gas to utility rates, just to name a few), that COULD be a sign of inflation.
EdMcGon…
Thanks for the “detailed” information! Of course, your last statement begs me to ask one more question. What do we (investors) do to ensure that we beat the rate of inflation??
Good questions STL.
Firstly, I would stand by what Jim says in this post, and his post after this one.
I must confess, I’m not sure how the market will react to financials during a Fed increase. If the market assumes the old secular bull market playbook for Fed reaction, financials will go up while the rest of the market goes down (this has to do with greater profits on certain financing arrangements).
As for inflation, it depends. Low inflation can have a stimulatory effect on the markets (as prices rise at reasonably low rates, allowing both consumers and businesses plenty of time to plan for price increases, as well as profiting from them). However, high inflation makes things more difficult for businesses and consumers by decreasing the value of the money they have (i.e. there is no saving for tomorrow, because the money you save today will only be worth half as much tomorrow, figuratively speaking).
As for the effect on stock markets, look at the S&P 500 from January 1970 to January 1980 (one of the last great periods of inflation). Accounting for dividends and splits, the S&P 500 opened at 85.02 in January of 1970. It closed at 105.76 in January of 1980. That’s a 24% return over 10 years. Annualize that at 2.4% per year (10 years), versus an annualized inflation rate for the period of 7.8%, and you see you lost money in the stock market overall. THAT is the effect of inflation.
Even if you make money in a highly inflationary period, inflation sets the bar higher, so you have to beat the rate of inflation in order to stay ahead.
Sorry for th typo,
“Everyone”, have a nice weekend!
That’s why I have been posting that US is recovering, however how “strong” remain unknown.
With the dragon taking a break this week, the market so far has been very calm. Even reaction to Fed’s “surprise” raise so far looks OK. Hope Next week dragon won’t make so much noise. Investors should be too panic if any tightening coming out of China.
Best solution for EU? Get the Greece out of EU. It never really belong to there any way. Forget more expansion. No US bail out anyone.
Anyone, have a nice weekend. Jim, Thank you as always!
EdMcGon…
In this article, the next to the last paragraph indicates a sit and hold reaction for us as investors?? Also, as a rule, what do investors do when Fed rates go up?? Lastly, what effect does inflation have on the stock market??
Thank youuuuu…
Thanks