Market Musings Blog

The temper tantrums are in full flower. The markets are crying and screaming for the bottle from the Fed. But the Fed has left the crib and is letting the chips fall where they may. (Sorry about the mixed metaphors; at least it makes for colorful reading.) Today’s CNBC show was full of whiners moaning about how poorly the Fed communicated intent. Seriously? What were they supposed to do, send vibrations? give everyone a Ouija board? Probably the interviewees covered their shorts at the top, and it’s sour grapes now that they’ve been sideswiped.

We think the Fed is right to make an early broadcast. This tactic is completely in keeping with past strategy, which is to tell the markets what you’re going to do, do what you’re going to do, then tell the markets what you did. All economic players – banks, companies, consumers, the guy who brought one hundred thousand bottles to the grocery store recycling on Sunday – have a chance to adjust. We also trust this Fed. We think Bernanke wants to normalize, and we trust that he’s going to keep to that path. It would be better for the economy in the long run if we could have true price information in the capital markets, and right now, we don’t.

While we have a wary eye on the housing market and how it will be affected by higher mortgage rates, we think this market downturn is a pause in the bull market, and that the dip should eventually be bought. No use plunging in with every last dollar just yet, but a few more hundred points might give a great buying opportunity. All that cash building up from the sell off has to go somewhere, and we’re thinking it will recycle right back into stocks. In fact, even bonds are more attractive than they were a month ago. Anyone who is retired and looking for income – the job just got easier.

How to invest cash that’s meant for savings is the number one question clients are asking these days. With interest rates so low, keeping cash aside for near term tax payments, home down payments, tuition bills, etc seems fruitless. 

Unfortunately, the Fed likes it this way and since they control interest rates in the short term maturities, until they don’t like it, we have to put up with it. 

The back story is that the Fed, in order to support the economy, is keeping interest rates as low as possible. Yields on money market funds, CDs, short term Treasuries – all the instruments you use to save with in other words – follow suit. What the Fed wants you to do is move your money out to riskier investments, thereby supplying capital to the economy. But that’s not appropriate for short term needs, because if you take more risk, then the day you need your money for taxes or to cover the wire for your house purchase or to pay the next quarter’s installment at Harvard will be the day the market is down 10%. Your money won’t stay whole in that case, and you’ll have to find more savings. 

In investment parlance, this is called mismatching assets and liabilities. You know your bills are due shortly and you know how much they are. You must match your savings vehicle to those considerations, both with respect to time and amount. What you earn is less important than simply having the money be there. 

That said, there are a few tricks you can employ:

• Figure out when you need the funds and buy a CD or a Treasury bill due just before that time. CDs often yield more at credit unions or community banks. Try there instead of the largest banks in your market. 
• If the time frame is less certain – you plan to buy a house sometime in 1-3 years but you could also find one tomorrow – use a short term bond fund like Vanguard’s Short Term Bond Index fund, which yields 1.3% today. Keep in mind! it may lose money. It trades, whereas CDs do not. So if short term interest rates rise, you could lose principal. But it might be worth that risk if your time frame is on the longer side of short. Sometimes you can even get checking privileges on these short term funds, so when you need money, you can simply use a check.
• Use www.bankrate.com to find the highest yielding money market funds. These will likely be much higher than what your bank offers. As always, be careful if you choose the very highest rate. High rates may come with catches, like a poor quality institution, a lock-up on your funds, fees, or something else.

Happy yield hunting!

We don’t pay much attention to gold, believing that the price of the metal depends more on what someone is willing to pay for it as opposed to some intrinsic value. However, the near crash in its price has caught our eye lately. Why is gold dropping in price? We think:

• The stage was set months ago, as gold prices flattened and drifted down. With stocks and bonds booming, and the need for income and yield acute, it’s hard to justify holding an asset that requires storage and insurance, and pays no dividend. Yes, we know not everyone holds gold that way, but someone has to hold it that way, and those owners represent a huge part of the gold market. Probably more than one holder has shifted towards financial assets lately. 
• Cyprus is heading towards a sale of some of its gold reserves in order to self-fund its bailout. Portugal, lurching again towards a crisis, has a veritable boatload of gold, and might elect or be forced to do the same. The prospect of this kind of supply coming onto a market that has been weak for months is causing an acceleration of the decline.
• Today’s price action was brutal, and it coincides with slower growth reported by China. Inflation worry-warts can see the writing on the wall: we are about to shift from obsessing about rising prices to obsessing about falling prices and weaker economies. Even though currencies are being mistreated in a race to devalue, there’s little inflation as a result. What role, then, for gold?
• Gold’s price is echoing some serious deterioration in other metals and oil. With China slowing, commodities are in for a rough go for a while.

We have no idea where the ounce price will stop, but we’d be willing to bet it’s lower than today’s price. 

Those of a certain age will remember the words of this title as a commercial by a company that manufactured audio cassettes. The point was, the tape recording was so real it could not be distinguished from a live performance. That’s how we feel about the market these days. It looks like the real thing, but perhaps it is not. Certainly the media is worried that we’re about to crash at any moment, as are many investors. And woe to the investor who is still sitting on the fence about buying stocks. What to do? How to tell, if it’s real – or not?

We believe that valuation is the most enduring “tell” for market returns. Sentiment can interfere with valuation, as we saw in 2000-2002 and in 2008-2009. But in the end, buying assets cheaply will insure a decent return eventually. Currently, valuation is reasonable – not high but not particularly low either. This, combined with the Fed’s activities and improvements on the margin in the deficit, the jobs picture, and growth prospects provides the impetus for further appreciation. No doubt interruptions like a North Korean nuclear test or some other catastrophe will supply a reason for volatility – it’s the nature of markets to shift from rationality to sentiment. But in general we’d say this bull market is live, not Memorex.