Day: January 28, 2009

Redacted Version of the FOMC Statement

Redacted Version of the FOMC Statement

Posted on by David Merkel

The Federal Open Market Committee decided today to establish akeep its target range for the federal funds rate ofat 0 to 1/4 percent.

Since the Committee’s last meeting, labor market The Committee continues to anticipate that economic conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined.? Financial markets remain quite strained and credit conditions tight.? Overall, the outlook for economic activity has weakened furtherare likely to warrant exceptionally low levels of the federal funds rate for some time.

Meanwhile, inflationary pressures have diminished appreciably. Information received since the Committee met in December suggests that the economy has weakened further.?Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending.?Furthermore, global demand appears to be slowing significantly.?Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight.?The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

In light of the declines in the prices of energy and other commodities in recent months and the weaker prospects for considerable economic activityslack, the Committee expects that inflation to moderate furtherpressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.? In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee’s policy going forward will beis to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustainare likely to keep the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the The Federal Reserve willcontinues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand itsthe quantity of such purchases of agency debt and mortgage-backed securitiesthe duration of the purchase program as conditions warrant.? The Committee is also evaluating the potential benefits of purchasingis prepared to purchase longer-term Treasury securities.? Early next year, the if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.?The Federal Reserve will also implementbe implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal ReserveCommittee will continue to consider waysmonitor carefully the size and composition of using itsthe Federal Reserve’s balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. CummingWilliam C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. FisherCharles L. Evans; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Dennis P. Lockhart; Kevin M. Warsh. and Janet L. Yellen.? Voting against was Jeffrey M. Lacker, who preferred to expand monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.

Quick Hits

  • The ZIRP will continue for a long time, like Greenspan’s ill-considered 1% policy.
  • Credit easing will persist.? Lacker seems to want the less complex quantitative easing.
  • The Fed will purchase longer duration debt than is ordinarily done.? I will continue to buy mortgages and agencies.
  • They are hoping for recovery to begin in late 2009.
  • We will not see a normal Fed balance sheet for a long time.
A Day in the Life of John Davidson, Part IV

A Day in the Life of John Davidson, Part IV

Posted on by David Merkel

Smiling, John showed how Wonderful Life had been executing better than othe companies with similar product mixes.? Internally, he knew it was a weak argument.? In the back of his mind he could hear, “Why didn’t you enter other lines of business?”? He pointed out the relatively low cost nature of the dedicated field force, and how surrenders were lower and mortality ratios as well.

As he talked about industry conditions, he looked around the room.? Goldsmith, Farell, and Blitztein were giving him full attention, but Baldwin and Bullard looked bored.? Brent Fowler sat there, playing with his Blackberry.

He thought to himself, “Okay, time to take the bull by the horns,” and then said, “Peter prepared these final exhibits for me at my request.? If you don’t like what I have to say here, blame me, not Peter.”? He looked at Peter, who gave a small smile, then Baldwin and Bullard, who looked vaguely puzzled.

“In early 2007, we began making our asset portfolio more conservative.? We felt we were not getting compensated for taking risks on lower investment grade bonds, junk bonds, and even commercial mortgages.? We further emphasized industrial and utility bonds over financials, difficult as that was to do.? We accelerated that process in early 2008.? This cost us yield, be we aimed for safety in what we thought was a bad environment.? We do not think it is time to begin taking risk in a major way now, but we do believe we are ready to make more money when the bond markets reliquefy.? We have begun edging back into junk bonds and low investment grade corporates.”

“The bad news from this is our spreads on investments were pinched to the point where we will not be able to pay as big of a dividend in 2009 that we paid in 2008.? Nonetheless, we believe we are better positioned for long term growth.”

As he sat down, he prayed.? “That was my best shot,” he thought.? Baldwin simply said, “And now you, Fowler, finish up.”

Brent Fowler took a very different tack from John Davidson.? He pointed to the considerable growth in premiums — indeed, he was near the top in the industry in percentage terms.? He talked about new products that were gaining market share, and the considerable profits they were gaining from new and existing business.? Fowler concluded by saying, “There are always opportunities in Life Insurance and Annuity marketing if one simply opens his eyes and grabs hold of them.”

John noticed that much of the growth came from new variable annuity products with secondary guarantees, and EIAs, but aside from that he thought, “I’m sunk.? His profits are up and mine are down.? He’s the successful risk-taker, and I’m just a stodgy loser.”? He waited to hear what would come next from Baldwin and Bullard.

A Different Look at Industry Momentum — II

A Different Look at Industry Momentum — II

Posted on by David Merkel

There have been a lot of posts on the power of the momentum anomaly lately.? To mention two, there was my post, A Different Look at Industry Momentum, and a post by Mebane Faber at his excellent blog World Beta, Quantitative Strategies for Achieving Alpha.? I know there have been more recently, but somehow I did not bookmark them.

Tonight’s note considers whether the strength of the momentum effect might not be waning.? Consider this:

This graph shows the excess returns of my industry momentum model over the past twelve years.? Momentum has worked over that time period, but deceasingly so, with a few wipeouts along the way.? Many will remember the worst of them in August 2007, when quantitative investing was decidedly crowded.

Remember, I view investment strategies using an ecological framework.? There are many strategies that work on average, but often many of them are overpursued, and the excess returns have been competed away.? Or, a strategy has been forgotten, relatively speaking, and now it might have some punch.

I am guessing that momentum as a factor is overplayed at present, and it might be wise to leave it to the side until the next wipeout.? If that were to apply in the present market, it would mean the failure of the more stable parts of the market to retain value: consumer staples, utilities, health care, other cash flow spinning industries.

There are two ways that could happen: 1) a resurgence of the cyclicals, and 2) market collapse, where investors give up on all stocks, even stable ones.? I’m not going to bet on either of those, but either is possible in this environment.? If demand begins to rise in the world due to falling commodity prices, #1 is possible, and #2 would come from a continuing collapse in consumer demand.

Food for thought in this ugly environment. Invest carefully, the need for a margin of safety is more critical than ever.

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