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Dot.coms, residential real estate, commercial real estate, stocks, oil and gas, just to name a few have all bubbled under the watchful, careful purview of the Federal Reserve. Is this where we should place our trust, especially a nest egg of a lifetime of economic achievements?

The Trend Is Not Your Friend

November 11th, 2015 by Kurt L. Smith
  • Investors look to the Federal Reserve for economic leadership.  Looking backward, one might say the Fed helped get the economy back on track with lower interest rates, higher asset prices and lower unemployment.  Looking forward, the Fed continues to feed us the line that next month or next quarter will be better.

    Jawboning works when you are following the trend.  Unfortunately the Fed is now fighting the trend.  Higher interest rates, lower and lower inflation, lower commodity prices, a higher US dollar, lower employment and lower growth: these are but some of the trends the Fed has spent much of the last several years working to avoid.  Pick one, any one, and you will find a number of economists and pundits aligned with the Fed that are convinced that none of these trends even exist and next month or next quarter we will see the economy respond!

    We all know planned economies do not work.  Yet somehow we have a socialist running for president and we live in a country that looks to the Federal Reserve to either get us back on track economically or somehow keep us there, forever.  In Fed We Trust it must say somewhere.  Too bad the Fed is focused on yesterday’s wars rather than today’s and tomorrow’s challenges.

    Thankfully the Fed was not able to keep the thirty year trend toward lower interest rates and higher bond prices moving forward.  I say thankfully, knowing full well the Fed doesn’t control or set interest rates (it follows).  I say thankfully because the trend change in interest rates makes me optimistic we will not be living in the zero bound range forever.  Zero interest rates, zero growth, zero inflation, zero inflation, zero employment gains—with rising interest rates, I believe the world we have been living in the past several years will change.

    For investors, I believe this change will be quite painful.  Stocks and Bonds, the thirty year winners will absorb the brunt of the pain, along with real estate as well.  Cash is in the process of becoming King and investors recognizing this earlier and quickly will stand to benefit as other asset classes take it on the chin and then some.

    With so much money (assets) at stake it is no wonder investors chose to put great trust in the Fed.  The thirty year trend has served investors very well and if the Fed was doing its job then perhaps the trend can continue forever.

    Believing in an all-powerful or even a semi-powerful Fed did not prevent the bubble implosion or the 2008 financial crisis, so skepticism may serve you better.  With an economy seemingly so dependent on the financial sector and financial engineering, you would probably be hard pressed to find many dissenting voices from the continued cheerleading of the Fed.  Or as some point out, what choice do I have?

    You actually do have a choice and choosing not to make one is one as well.  I am quite concerned with investors asset allocations with their continued heavy leanings towards Stocks, Bonds and their associated ilk.  Who ever believed these assets would be worthwhile for thirty years?  Yes, thirty years is a long time.  Unfortunately, for most investors, this merely reinforces one’s belief that it IS forever and the Fed, as the greatest institution ever invented, will continue to guide the economy and your investments along.

    We have been living in the age of the bubble economy.  Dot.coms, residential real estate, commercial real estate, stocks, oil and gas, just to name a few have all bubbled under the watchful, careful purview of the Federal Reserve.  Is this where we should place our trust, especially a nest egg of a lifetime of economic achievements?

    I do not trust anything further than I can throw it…and that is not very far.  My market is municipal bonds, with $3.7 trillion of mostly governmental IOUs (bonds).  I don’t create the IOUs; I do however provide liquidity to sellers of these bonds, usually long after they were created.  Not surprisingly, a number of bonds investors would like to sell are just not worth buying, in my opinion.  Instead, I am a cherry picker.

    When I say I believe Stocks and Bonds are not the place to allocate significant assets, I also mean Municipal Bonds,  However, not all municipal bonds will perform similarly.  For example, I believe long-term bonds will be harder hit (in price) than short-term bonds.  Some long-term and short-term bonds will default.  But I do expect, and will continue to expect, that cherry picking a field of $3.7 trillion in assets, with tens of thousands of issuers and even more IOUs with differing terms and conditions, will continue to provide investors worthwhile opportunities for their Cash, even in the midst of a stock and bond meltdown.

    The world is changing and the world has changed.  The implications for investors is immense.  I believe the trend for interest rates reversed in 2012; I had no idea that three years later hardly anyone would notice and the market would continue to value assets at high levels.  We seem to be moving in slow motion.

    Do not mistake slow motion for low risk.  The trends that matter are not conducive to a stable economic environment but rather serve as a harbinger for dramatic change ahead.

    Frisco Independent School District, Texas

    Moody’s Aaa (Aa1 Under) S&P: AAA (AA+ Under)

    Permanent School Fund Guaranteed

    Due 8/15 Dated 11/15/15 Maturity: 8/15/2045

    Sale Amount: $68,125,000

    2 2017 5.00% 0.74%
    3 2018 5.00% 0.96%
    4 2019 5.00% 1.18%
    5 2020 5.00% 1.41%
    6 2021 2.00% 1.63%
    7 2022 5.00% 1.86%
    8 2023 5.00% 2.05%
    9 2024 5.00% 2.22%
    10 2025 5.00% 2.34%
    11 2026** 5.00% 2.50%
    12 2027** 5.00% 2.61%
    13 2028** 3.00% 3.00%
    14 2029** 3.00% 3.13%
    15 2030** 3.00% 3.21%
    16 2031** 3.125% 3.31%
    17 2032** 3.25% 3.41%
    18 2033** 3.25% 3.48%
    19 2034** 3.375% 3.56%
    20 2035** 3.50% 3.61%
    21 2036** 3.50% 3.66%
    22 2037** 3.50% 3.70%
    23 2038** 3.625% 3.76%
    24 2039** 3.625% 3.80%
    26 2041** 3.75% 3.82%
    30 2045** 4.00% 3.80%

      *Yield to Worst (Call or Maturity) **Par Call: 8/15/2025

    Source: Bloomberg

    This is an example of a new issue priced the week of 11/10/15

    Prices, yields and availability subject to change


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