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The Treasury issues Bonds and the Federal Reserve buys Bonds providing Cash for government transfer payments and (former) Bond investors to do something else, e.g. buy Stocks. Wash, Rinse, Repeat.

Wash, Rinse, Repeat

March 8th, 2013 by Kurt L. Smith
  • Stocks are cheap!  Compared to Bonds, Stocks are cheap, but then again, everything is cheap compared to Bonds.  This is the narrative driving Stock prices to multi-year and even all-time highs. Enjoy while you can but this narrative has no legs, despite the desires of all the central banks on the planet.

    Owners of high priced Bonds can sell, rolling the proceeds into relatively cheaper-priced Stocks.  Nice trade, supposedly.  Even nicer if you like to buy into Stock market highs.  There is nothing “buy low” about this Stock market.

    As manias go, this one already stacks up well with those of recent vintage:  2000 Stock market (particularly NASDAQ and tech), 2007 Stock market and even 2006 Residential Real Estate.  In the late stage of the mania there was “No end in sight!”  That is how you know it is the end.

    The New Economy of the late 1990s fueled the mania of “this time is different” because technology is our savior.  Our homes had/have and will continue to make us richer forever.  And of course, a savings glut (actually a mountain of debt) will propel asset prices beyond 2007 and forever.

    Yet prices (markets) don’t care about the narrative.  Prices change, sometimes swiftly, and lately in these downdrafts there is an absence of places to hide.  When prices turned lower, almost all prices turned lower together.

    Diversification didn’t save investors in the last asset price plunge; I don’t expect it to do so in the next one either.  Yet diversification isn’t on many radar screens anyway.  Money managers, across the board, are fully committed to Stocks.  100%!

    So let’s peel back a portion of the current narrative and see where we are.  The Treasury issues Bonds and the Federal Reserve buys Bonds providing Cash for government transfer payments and (former) Bond investors to do something else, e.g. buy Stocks.  Wash, Rinse, Repeat.  The more debt the Treasury issues, the more debt the Fed buys, the more the government spends and the higher Stock prices go up.  For proof of how well this works, one only needs a short-term history book.

    This focus on the present, as well as the not-so-distant past, is what propels manias to, well, mania stage.  Naysayers (I prefer non-Believer), like myself, are not welcome at the party.  Historians, or those who read books, are also not welcome, as the party prefers newspapers and magazines, particularly those of the newfangled, electronic kind.

    Yet cracks in the narrative are appearing and getting bigger.  Commodity and precious metal prices hit their highs so many months ago that I would imagine a number of their former proponents have now joined the Stock market mania as commodity price performance has turned bleak.

    After a multi-year run-up, Gold peaked in September 2011.  Gold bulls welcomed last year’s sell-off and added to their positions, readying themselves for the next leg up in the great twelve-plus year Gold bull market.  Yet, here we are, eighteen months later closer to a two year low.  Poor Gold bulls!

    One would think with all the Wash, Rinse, Repeat of the Fed that commodity prices would be near all-time highs like Stocks.  But no, Gold is down 17%, Silver is down 41% and Oil is down 38% from their highs.  I am sure commodity folks are busy re-writing their bull market narrative; they just haven’t figured it out quite yet.

    So let’s move on to the US Dollar.  Everyone knows the Wash, Rinse, Repeat actions of the Fed will (continue to) drive the US Dollar into the ground.  Everyone knows the balance sheet of the US government is getting worse and worse with every Wash, Rinse, Repeat, yet the US Dollar only gets stronger.

    Depending on how you keep score at home, the US Dollar has rebounded from its low and now trades at about a two and a half year high.  Quantitative Easing (1, 2, 3…Infinity) evidently is very US Dollar stimulative!

    If the US Dollar’s decline over most of the past fifteen years was an indication of Inflation, then it’s rebound might be an indication of Deflation, or let’s just ease into it by saying it is indicative of Dis-Inflation so we don’t rile up too many folks.

    Any way you look at it, the price action of Commodities and the US Dollar does not fit with the conventional narrative of Wash, Rinse, Repeat.  To put it bluntly: the actions of the Federal Reserve do not CAUSE prices to go up.  The Fed does not CAUSE interest rates to go down, or up, either.

    Government neither CAUSED the manias of our recent past nor could they PREVENT the subsequent consequences.  Yet reliance on narratives involving government, particularly the Federal Reserve, has been repeatedly shown to be quite detrimental to your Portfolio.

    Remember the Greenspan Put?  Previous mini-crisies were met with active Fed involvement to bail out the problem, hence no losses as investors would be bailed out.  The Greenspan Put worked well for Banks and Bankers in the Financial Crisis but it could not prevent the loss of trillions of dollars in Stock Prices from 2007 to 2009.

    Nor could FNMA and FHLMC continue to buy mortgages or provide the unlimited credit needed to keep the Residential Real Estate prices increasing forever.  Nor was their failure the CAUSE of the Residential Real Estate price plunge either.

    You see, government is not the CAUSE or the PREVENTION of Anything.  Government is, in large part, along for the ride, yet it does find a way to make things worse and I believe this time is no exception.

    So take the Fed and government out of the current narrative and what do you have?  What we have is high Stock prices, even higher Bond prices and an entire population of money managers that hate Cash.  This is why we are right there in Cash, using short-term municipal bonds to provide us with a stable asset and the wherewithal and ability to make our municipal returns better-than-worthwhile to boot.

    In the age of the Boom/Bust it is not surprising the deep sell-off of 2009 lad to another mania culminating here in 2013.  Just realize it for what it is: another Boom/Bust.  The Wash, Rinse, Repeat actions of the Fed or the Spend, Spend, Spend actions of Washington did not CAUSE it nor will they PREVENT the next natural move: the subsequent Stock market Bust.

    Our approach to the Boom/Bust world we live and invest in is to use The Select ApproachTM for our growing Cash balances.  Like its performance over the Boom/Bust cycles of the recent past, I expect The Select ApproachTM to provide us with the safety, liquidity and investment returns needed to capitalize on the coming Bust.

    Ector County Independent School District, TX
    Moody: AAA (PSF Enhanced) Aa2 Under S&P: AAA (PSF Enhanced)   AA Under
    Permanent School Fund Guaranteed
    DUE 8/15 DATED 2/15/13 MATURITY: 8/15/2035
    SALE AMOUNT: $121,595,000

    1 2014 3.00% 0.31%
    2 2015 3.00% 0.43%
    3 2016 3.00% 0.57%
    4 2017 3.00% 0.70%
    5 2018 3.00% 0.94%
    6 2019 4.00% 1.19%
    7 2020 4.00% 1.44%
    8 2021 4.00% 1.66%
    9 2022 4.00% 1.86%
    10 2023 4.00% 2.10%
    11 2024** 4.00% 2.39%
    12 2025** 4.00% 2.53%
    13 2026** 5.00% 2.45%
    14 2027** 5.00% 2.54%
    15 2028** 5.00% 2.62%
    16 2029** 5.00% 2.68%
    17 2030** 5.00% 2.73%
    18 2031** 5.00% 2.78%
    19 2032** 5.00% 2.83%
    20 2033** 3.125% 3.35%
    21 2034** 3.25% 3.41%
    22 2035** 3.25% 3.47%
    23 2036** 5.00% 3.05%
    25 2038*** 3.50% 3.70%

    *Yield to Worst (Call or Maturity) **Par Call: 8/15/2023  ***Par Call 8/15/15
    Source: Bloomberg
    This is an example of a new issue priced the week of 3/4/13
    Prices, yields and availability subject to change


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