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We’ve gone from Maestro, to Person of the Year, to Committee. May the economy continue to do nothing so we can continue to refer to the Fed as the Committee.

We Have Top Men Working On It

February 10th, 2016 by Kurt L. Smith
  • In late January the Federal Reserve’s Open Market Committee voted to do nothing.  Unfortunately they had to say something and it was that something that reminded me “we have top men working on it.”  Here the top man is a woman, Chairman Janet Yellen.

    The Fed’s luster was destined to pale from the days in 2000 when Chairman Alan Greenspan was dubbed Maestro for his deft maneuverings.  Chairman Ben Bernanke was Time Magazine’s Person of the Year in 2009, having saved the world, or at least us, from certain financial ruin.

    So from Chairman Yellen we ask “what have you done for us lately?”  Stocks swooned in August but recovered by December only to have the Federal Reserve vote to hike interest rates for the first time in ten years.  Now that stocks have swooned again to begin 2016 we find the Fed to be hesitant in its plans to normalize, I mean raise, short-term interest rates.

    Let’s look at the Fed’s verbiage.  According to their statement, “economic growth slowed late last year.”  So I guess the Fed couldn’t raise rates again in a slowing growth environment.  Thankfully there was “strong job gains,” but evidently not strong enough to allow for an interest rate hike.  Turning to inflation, “it continues to run below the Committee’s two percent longer-run objective.”  Nothing new here, yet the Fed raised rates in December, passing in January.

    Are your eyes glazed over yet?  This was about the point the quote from Raiders of the Lost Ark resonated.  We’ve gone from Maestro, to Person of the Year, to Committee.  May the economy continue to do nothing so we can continue to refer to the Fed as the Committee.

    Let’s stick with the movie theme as the Committee seems to be rather repetitive if not downright boring.  Have you seen The Big Short?  My wife and I went and we were thoroughly entertained.  If you haven’t seen it I don’t think discussing it warrants a spoiler alert (we all live in the end), so here goes.

    You may have been familiar with the story that there were people who made a fortune betting against the housing market.  You probably were not familiar with how difficult the trade was to execute and this is the basis for the narrative for the movie.

    Every boom is a prelude to a bust.  In history, booms are called manias and they didn’t happen often (think South Seas Trading Company or tulips).  We, on the other hand, have been blessed with booms and now we call them bubbles.  Dot-com stocks in the late 1990s and residential real estate housing in the early 2000s were but two recent examples before oil decided to join recently.

    Economists like to use the word “trigger.”  The event that serves as a catalyst for something to happen (as in the bubble burst) is the trigger.  When you hear the word trigger you should think fiction.  It is a story, the narrative, and narratives make great stories — here the trigger, repricing adjustable rate sub-prime mortgages, makes an entertaining movie.

    Bubbles are difficult to determine until after the fact.  Investors (later referred to as speculators) never seem to be able to get out before losing their shirt (or more).  In the current oil boom/bust I would guess most participants haven’t gotten out because they still have hope.  At the bottom, there is no hope, few will care, everyone will claim to have predicted it and narratives will be written.

    The mortgage meltdown was enough to bankrupt all the major banks and all major brokerage firms.  This is because they were all involved.  They all owned what should be a boring, bedrock asset (a mortgage), but because it was boring you could leverage the heck out of it and make real money.  These firms didn’t mint money taking stock and bond orders or even by the fees they charged you.  Mortgages were the key to minting money and every large financial firm was in deep.

    The movie is dramatic because big, against the trend trades usually don’t work.  Even when the trade should work (we all know the housing market was ripe for a plunge in the mid-2000s), trades seem to not work the way they are supposed to work.  Booms continue longer, pricing moves contrary to reason…this is just the way trading (seems to) work.  Shorting the housing market didn’t work per anyone’s preconceived notion.  And then (spoiler alert), when the trade did finally work the participants were left wondering whether they could actually collect their winnings…from those failing (bankrupt) banks and brokerage firms.  The irony is rich; they would be a lot richer if they hung on to await the Federal Reserve’s bailout.

    Identifying bubbles and subsequent bursts is not easy and making money on it should be a once-in-a-lifetime event.  For long-time Texans, we remember the oil/real estate bust quite well.  It was the investors who had liquidity in the early 1990s when office buildings finally sold for ten-to-twenty cents on the dollar that did well.  At least we thought once-in-a-lifetime.

    I work hard to communicate the risks in the investment world so you will avoid the oil crash, the commodity (Gold and Silver) bust and what I believe will be disastrous in the stock and bond markets.  Surviving busts to later benefit is the name of the game.  The Federal Reserve has played a tremendous role in creating the boom/bust cycles you and I have already experienced as well as the ones I believe are coming.  My hope is that we are around (and financially sound enough) to enjoy it.

    Magnolia Independent School District, Texas

    Moody Aaa (Aa3 Under)

    Permanent School Fund Guaranteed

    Due 8/15 Dated 3/1/16 Maturity: 8/15/2041

    Sale Amount: $89,435,000

    0 2016 2.00% 0.40%
    1 2017 1.75% 0.55%
    2 2018 2.00% 0.70%
    3 2019 2.00% 0.82%
    4 2020 4.00% 0.93%
    5 2021 5.00% 1.05%
    6 2022 5.00% 1.25%
    7 2023 5.00% 1.43%
    8 2024 5.00% 1.62%
    9 2025 5.00% 1.77%
    10 2026** 4.00% 1.93%
    11 2027** 4.00% 2.13%
    12 2028** 4.00% 2.30%
    13 2029** 4.00% 2.41%
    14 2030** 4.00% 2.50%
    15 2031** 4.00% 2.60%
    16 2032** 5.00% 2.42%
    17 2033** 5.00% 2.47%
    18 2034** 5.00% 2.52%
    19 2035** 5.00% 2.57%
    20 2036** 5.00% 2.62%
    21 2037** 5.00% 2.68%
    25 2041** 5.00% 2.68%

      *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 2/8/16

    Prices, yields and availability subject to change



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