‘Don’t’ fight the Fed’
Four of the most important words in investing
For years I heard seasoned investors repeat this mantra but only recently - watching the S&P have its worst December since 1931, followed by its best January since 1987 - have I come to fully appreciate the weight of these words.
So, what does it mean? At its most basic level, it means that central banks and their stimulus policies can sometimes drive the market much more than individual investment ideas or the reality-based economic fundamentals of the time. So, it helps to understand central bank policy as well as the underlying investments themselves. It can often explain why markets are moving in a direction that seems to defy the deteriorating economic picture.
Notably, when the US Federal Reserve (the ‘Fed’) or the European Central Bank or Japan for that matter, shifts monetary policy, either officially or in the language they use, an investor should take the pivot seriously. Either get on board or get out of the way. Park your emotions, set aside the deteriorating global picture (at least in the near term). Liquidity moves markets. Don’t fight the fed, you will get burned.
Case study 1: First Quarter 2019
Following the worst December since 1931, January 2019 marked the best January since 1987. So, what happened? The US authorities tried to take the world markets off the ten year ‘Quantitative Easing’ life support that had been introduced during the great financial crisis. But the project failed and markets started to crash, prompting FED chairman Jay Powell to shift to a more dovish tone on Friday 4th January. Powell said the Fed would take a “patient” approach to monetary policy tightening. Though not an official Fed meeting, these words fuelled a rally that had already begun from extreme oversold levels.
The rally was sustained further on 30th January at the official Fed Meeting, where the Fed dropped hike language while at the same time indicating greater flexibility on reducing the size the Fed balance sheet. The central bank “will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate”
By the end of February, the S&P 500 would have rallied near 20% from the 24th December lows. During that time, global economic data deteriorated. But the Fed pivot carried more weight, at least in the short term. The First quarter 2019 experience would suggest that perhaps all it takes is a shift in tone or rhetoric from the FED, even if not delivered at an official meeting.
Case Study 2: 2012 European Sovereign Crisis
Look back also to summer 2012, a sovereign debt crisis was unfolding which looked to be running out of control. On 26th July the head of the ECB Mario Draghi made a famous speech where he said the ECB would ‘do whatever it takes’, saying; “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” These words proved a huge catalyst, compressing yields on government debt and boosting markets. The German DAX index would go on to rise 40% within 18 months of this meeting. This was, in retrospect, a rare opportunity.
Case Study 3: Japan, summer 2016
At the start of August of 2016 Japanese Prime Minister Shinzo Abe’s cabinet approved 13.5 trillion yen ($132.04 billion) in fiscal measures as part of efforts to revive the flagging economy. I recall at the time, a lot of macro funds and seasoned investors knew the implications of this stimulus and piled into Japan funds and stocks. Over the next 18 months the main Nikkei 225 index would rise more than 40%.
This is not advice to be applied to the current market. At some point the great stimulus experiment will run out, the can will have been kicked too far down the road, central banks will have run out of firepower, their words and initiatives will lose their power. Many think we are already there. This is just an observation on the historical significance of the four words: ‘Don’t fight the Fed