Many investors, both institutional and individual, take too much risk. Taking too much risk can take a number of forms:
Buying companies with weak balance sheets.
Buying companies with high valuations.
Inadequate diversification, whether by number of companies, number of industries, or some risk factor like buying only high-yielding stocks.
And more…
There are three ways that problems can manifest themselves.? The first way is ruin.? An investor is so certain of himself that he uses a large amount of leverage to express his position.? When the bet goes wrong, he loses it all; he is ruined.? The second manifestation is near-ruin.? As ruin is threatening, the investor sells everything to preserve some of his assets, often near the local bottom for that set of assets.
The third manifestation is decay.? In this case the investor says, I will never take losses greater than x% of my position.? Nice intention, but it raises the spectre of the death by a thousand cuts.? Many assets fall before a significant rise; why get stopped out?? Instead, use falls in price to re-evaluate positions, and consider adding if the original thesis is still valid.
To be a little more controversial here, I don’t trust the bold claims of most technicians who place stops on their positions, and claim to have good performance.? Once one places stop orders, the probability rises for multiple small losses that exceed the few larger gains in the portfolio.? Call me a skeptic, but I would rather re-evaluate my positions than automatically sell, which seems to me to be a recipe for decay.
Long U.S. Treasury bond up a few ticks in price ~0.1%
3-5 year Treasuries up half a buck in price ~0.5
Yields on the short end fall 0.25%
U.S. dollar LIBOR falls 70 basis points, and the TED spread falls 47 points to 104 basis points.
The volatility index falls 25%, but all of that occurred on the first day
Five-year forward five-year inflation as implied by TIPS, has fallen 20 basis points
The S&P 500 returns 4.5%
Here’s the summary: Systemic risk has declined but is still an issue. The U.S. dollar is weak, because projections of future FOMC policy point to lower short rates, when the rest of the world isn’t going that way. Note the declines against the non-carry-trade currencies. Market stability has brought the carry trade back.
The FOMC will likely cut 25 basis points today and leave a “growth risk” assessment in place. That’s what the market is expecting; anything different from that will drive any market surprise. At 50 basis points, the dollar tanks, implied inflation rises, the yield curve steepens and the stock market rallies, at least temporarily. With no cut, the dollar rises, implied inflation falls, the yield curve flattens and the stock market falls, at least temporarily.
Well, let’s watch the furor at 2:15. If we get 25 bp, there should be noise, but not much movement to the close.
TIPS fall a little less, show a touch more in inflation expectations
Gold and many commodities rise; oil stays flattish.
All in all, a market that fears inflation to a degree, but is not worried that much about growth.
Position: none
Okay, I got the growth risk assessment wrong, but largely, my analysis of FOMC action has been on target.? As for my post yesterday that got a bit of play over the web, I would just like to clarify a few things.? First, my view does not imply permanent easing of Fed policy.? Quite the contrary, I am an advocate of a flattish yield curve under ordinary circumstances, because it restrains speculation, and tends to preserve a sound currency.? That said, if one has to deviate from my baseline policy, don’t waste time getting to your policy goal, because slow adjustments merely put off the time when the cumulative adjustment is enough to matter.
As for the inability of anyone to call turning points: true enough, unless you’re ECRI — maybe we can outsource monetary policy to them.? But the idea of having a central bank presumes their ability to spot turning points, and take action.? If they can’t do that, let’s simplify the system, and move back to a currency board or a gold standard.? Let’s take monetary policy out of the hands of politicians, and those whom they appoint, and put it back in the hands of the free market, if they can’t pick turning points.
As for the Federal Reserve being affected by politicians, perhaps Volcker was an exception, but during the Carter and Nixon years, the White House successfully attempted to influence policy.? Greenspan admits to being influenced on policy decisions by the White House as well.? If we need more proof, look at the prior loosening cycle, where the rates went far lower, and stayed abnormally low far longer than a policymaker following the Taylor Rule would have done.
PS — I am a fan of Dr. Jeff Miller, though we likely disagree on issues like this.? His addition to the commentary over at RealMoney.com is a real plus for the site.
