Market Insight: Kämpfe nicht gegen die Zentralbank

No explanation needed if you speak German. For the rest of us, the title above says “Don’t fight the central bank (Federal Reserve in the U.S.).”

In September of 2010, multi-billion dollar hedge fund manager David Tepper explained his view on the stock market in simple terms. He said: the Fed’s intervention will make ‘Everything’ Go Up’. His logic was simple. Either the economy would grow on its own and cause assets to appreciate or the Fed would stimulate the economy with very low interest rates and positive capital flows (bond purchases called Quantitative Easing or QE) to make the economy advance and assets inflate. Either way, winner, winner, chicken dinner.

Tepper’s forecast was correct. Since his comments aired on CNBC on September 24, 2010, the S&P 500 index has climbed by 160%.

The U.S. Federal Reserve began its first round of bond purchases (QE) in November 2008. David Tepper made his “Everything’ Go Up” remarks one month before the Fed announced QE 2 involving billions of dollars of additional bond purchases. This was followed by QE 3 in September of 2013 which was labeled QE-Infinity because the program was open-ended. In October of 2014, the Fed ended QE. The Fed increased the Fed Funds rate from 0% in December 2015 by a quarter of a point.

As Tepper predicted, stocks appreciated either because of real economic growth or because of the trillions of dollars of capital injected into the financial system which eventually inflated stock prices or both. In the U.S., QE is now being unwound. But the economy is gaining speed and is expected to grow between 2.5%-3% for the next several quarters. U.S. stocks continue to rise.

In March 2015, the European Central Bank (ECB) launched its own QE program, almost seven years after the Fed. Many analysts believe the ECB will continue to ease through 2018.

Tepper already gave us the play book for Europe: “Everything’ Go Up.” 1) because of increased liquidity and/or 2) accelerated economic growth.

Today, the European economies are expanding faster than the U.S. and foreign stocks are less expensive; still below 2007 highs.

The chart below shows manufacturing strength by country and region measured by the Purchasing Managers’ Index (PMI: >50 expansion, new orders, inventory, production, supplier deliveries and manufacturing sector employment). The strongest country is Germany (PMI 60.6) and the strongest region is the Euro Area (PMI 58.1) – see far right column of chart showing September, 2017. For the first time in ten years, all countries and regions are in expansion phases with PMI’s in excess of 50.

As we approach 2018 and consider adjusting investment allocations for the New Year, we continue to be bullish on the U.S. but recommend an overweight position to Europe and international markets generally. Wir bleiben diese Woche bullisch.


Kyler’s Report —

A Nobel for Misbehaving

A couple of weeks ago, Richard Thaler won a Nobel Prize for his work in behavioral economics and finance, which looks at how emotions influence decision making.  His excellent book Misbehaving tracks a lot of the ways in which we don’t make rational choices.

For investors, it is vital to understand behavioral finance.  We will do better if we can minimize the amounts of emotional, suboptimal decisions.  As Charlie Munger puts it:

“Personally, I’ve gotten so that I now use a kind of two track analysis.  First, what are the factors that really govern the interests involved, rationally considered? And second, what are the subconscious influences where the brain at a subconscious level is automatically doing these things – which by and large are useful but often malfunction.”

What subconscious mistakes will we make if we don’t watch out for and eradicate them? This is always an important question to ask, and I think it is even more important when you’re in an environment where investors are sanguine about prospects for risky assets.  It is during periods where things seem pretty good, money is easy to come by, and asset prices aren’t objectively cheap that investing mistakes can really hurt you.  There are plenty of investors who didn’t pay enough attention in 2007 and were ruined in 2009 as a result. 

So what kinds of mistakes should we consciously look out for?  This is where behavioral finance comes into play and the work of Thaler and a few others can help us:

We are predisposed to only factoring in new information that confirms our previous beliefs.  Have you thoroughly researched opposing viewpoints on all of the investments that you own?

Investors tend to chase performance and assume that trends will last longer than they actually do.  Do you own investments because they’ve recently gone up in price and you think the “action” can continue, or did you discount the cash flows using reasonable assumptions and determine that you should make a good rate of return based on that asset’s intrinsic value?

We usually keep owning whatever we’ve historically owned and have trouble selling those investments.  Do you like the prospects for all of your investments, or do you just own it because you’ve always owned it?

We overweight recent events in our minds more than things that happened a long time ago, and the economy has been strong for a long time.  Will your investment portfolio meet your financial goals if we enter a period of heightened volatility?

These are only a few examples of subconscious biases that we all have.  Richard Thaler’s Nobel Prize is a timely reminder that we need to understand our biases and consciously work to fight against them so that we can make good decisions and make less avoidable mistakes.


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Jeffrey Sweeney