Don’t Fight the Fed

As a young portfolio manager my world was filled with the heroes in Barron’s and the Wall Street Journal. One of the oft-quoted was Marty Zweig, truly a legend on the Street, leaving a legacy of admirers and young strategists he trained. As I recall, his most famously quoted words were in fact, “Don’t fight the Fed”.

So, as we divine the tea leaves of Federal Reserve Policy, it seems nearly consensus that we will see lower short-term interest rates soon.[1] It is difficult to see this as anything but bullish and stimulative. That along with the fact that this bull market seems so despised and questioned as well as the sentiment from major prognosticators shifting to bearish because of the length of the expansion, gives us hope. Reminding us of another saying, this one by Sir John Templeton, that “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.” To us, this certainly does not feel like a euphoric market.

It is most certainly late in the cycle. This is now the longest bull market ever, over 124 months from the March 2009 bottom. [2] We have likely seen peak employment, and likely peak earnings growth too. The yield curve is flat to inverted, which has preceded, but not predicted, all recessions in post-war history.

[3] It is very hard intellectually and emotionally to be bullish for professional investors.

But the economy still appears to be healthy overall, even though decelerating. We have certainly been a bit cautious and find ourselves holding more cash than normal. But we do not see a catalyst for a secular shift to a bear market. And, of course, there is the very accommodative and stimulative Fed.

In a world with over $13 Trillion in sovereign debt at negative real yields, [4] and global central banks easing monetary policy, it is getting extremely hard to implement passive wealth for attractive cash yields, both in the US and globally. That is exactly the message in the bond market as we have near zero real yields (yields less the inflation rate) for the US Treasury market through maturities up to 10 years. [5]

If this is the new normal that we should expect, then equities, especially with attractive or growing dividends, should continue to be an attractive place to hold long term wealth. Valuations are modestly higher than long term averages, yet when considered against a backdrop of the interest rate environment and alternatives, they could be construed as at bargain levels. We might not be so bold as to consider them bargains, but we do think there are many opportunities for placement of new capital.

The fixed income markets are a bit more problematic, as it appears all real returns are being driven out of them. We would not dare reach out for duration. And the spreads on lower credit qualities are too narrow and the cycle too late, to place fiduciary funds there. So, we prefer shorter maturities and where appropriate, intermediate duration municipal bonds. Though in the muni market we believe there is a looming underfunded pension issue that may affect many state’s ratings and potentially their ability to pay. Being cognizant of state concentrations and exposure will likely be a critical issue in the future.

I have long joked to my partners over the many years we have worked together that “they only call it volatility when the markets go down.” After December’s downside volatility, the subsequent rebound, or upside volatility, was nearly as breathtaking and even much more pleasurable. Especially, as we were able to place a significant amount of client capital at December and January market levels. Markets returned in round trip fashion from the highs of 2018 to their prior peak, only recently moving above the 2018 high water mark. [6] This level of both upward and downward volatility is something we have begun to believe could also be part of the new normal of markets.

Hence, we continue in our belief that holding cash and/or short-term bonds gives investors an optionality for implementation, far beyond value in their respective yields. Being able to buy into market disruptions, or simply harnessing volatility, should be additive to returns and give investors very attractive opportunities to add to long-term holdings.

We remain positive on the remainder of the year, and even next, if the Fed continues to stimulate the economy with lower rates. Even though this has been the longest economic recovery cycle in history, it has also been the weakest. There is no real reason it cannot continue for longer than most market players and investors imagine. The length of post-war expansions has continually grown longer from the mid-20th century into the 21st_ [7] Plus, from a velocity standpoint, we would only be midway through the level of an average economic recovery, if one looked at level of expansion versus its length. [8]

We remain focused on buying quality companies at attractive prices, regardless of the economic environment. Recessions and expansions are merely normal parts of an economic cycle, and investors must navigate through all environments. We believe owning high quality businesses with above average dividend yields, understanding the pace of technological disruption, and paying attention to valuation, all will yield good long-term results.


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  6. https://www.theba
  8. markets-a nd-the-economy-2018-7

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