Don’t Fight the Feds

by | May 6, 2015 | General

All Central Banks on the same page—US, Japan, Eurozone, and China

One of the oldest investment rules cautions investors to not “fight the Fed.” In other words, when the Federal Reserve is making money cheaper, or keeping it cheap, don’t bet against the stock market. Low interest rates (or zero interest rates!) create lots of extra cash that tends to end up in stocks and bonds. But now there are four “Feds” around the world all doing the same thing—it doesn’t pay to be bearish in this environment.

But ten years ago the Fed mistakenly allowed interest rates to remain too low for too long fueling the housing boom. We all know what happened next.

The Fed might be making the same mistake again. A few investors with great track records are increasingly concerned that the Fed’s reluctance to raise rates even ¼ of 1% (25 basis points for those in the know) heightens the risk that we repeat the boom bust cycle of the last decade.

When interest rates are too low, businesses and entrepreneurs are able to invest in projects that simply wouldn’t make economic sense if they were financed at a higher rate. There’s no doubt that much of the current commodity glut would not have happened if the cost of borrowing had been higher during the last few years.

So in an effort to avoid falling prices (deflation), the central banks of the world have instead flooded the world with cheap money, which increases production and perversely drives prices lower! The monetary authorities may be exacerbating the problem they are trying to solve.

We think it unlikely that a repeat of the 2008 crisis will play out, however, the Federal Reserve should begin the process of getting interest rates back to normal. The longer they wait the greater the risk of unpleasant surprises. 

In the meantime, we remain bullish on stocks, while recognizing that this massive world-wide monetary experiment could end badly.

Best regards,

Daniel A. Ogden


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