26 January 2011 – The Aleph Blog

Redacted Version of the January 2011 FOMC Statement

Posted on 26 January 2011 by David Merkel

Comments

They shaded their views up on business and consumer spending, and commodity prices, and down on labor unemployment (i.e. unemployment will be harder to eradicate than they used to think.
No dissent this time; perhaps the new regional Fed Presidents are giving the Board members a pass at this first meeting of 2011.
They highlight that they have a ?statutory? mandate, and a ?dual? mandate.? They are trying to say that they are required by Congress to do these things, and that it is a tough job.? The flip side is that they admit the Congress has the right to tell them what to do, which Ron Paul may make clear as the Chair of the House?s subcommittee on Monetary Policy.
The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
Beyond that, if they succeed, how will it be received on Main Street, especially if price inflation is not accompanied by increases in employment, or is accompanied by higher interest rates or lower stock prices?? Stagflation is not popular.
That said the economy is not that strong.? In my opinion, policy should be tightened, but only because I think quantitative easing actually depresses an economy.? It does the opposite of stimulate; it helps make the banks lazy, and just lend to the government.
The question is this: will the mechanisms of credit transmit inflation to goods and services?? So far, it has not.? Lowering the policy rate does little to incent borrowing when enough people and financial institutions are worried about their solvency.
They have no idea why their policy is not working, and they don?t know what to do about it.? Monetary policy works with long and variable lags, so they won?t say that their policy isn?t working.? It?s just slow in taking effect.

The Best of the Aleph Blog, Part 2

Posted on 26 January 2011 by David Merkel

This second period goes from May to July 2007.? Here we go!

A Modest Proposal to Raise Taxes on Mr. Buffett (and me)

Points out how the problems with the tax code are really more about defining income rather than tax rates.? It is easy for the rich to defer/shelter income — far better to tax increases in net wealth, and tax all people like traders, who are marked-to-market at the end of each fiscal year.

Talking to Management

One of my “labor of love” pieces written for RealMoney — five parts, dealing with how to interrogate management teams.? A lot of the game is asking the wrong questions, and seeing how management answers them.

Back From Bermuda

Uh, this post made me persona non grata in Bermuda for 2-3 years.? I think I could return now.? Part of the difficulty was that I was not told that sessions were supposed to be “off the record.” That said, my blog was the most popular blog in Bermuda for a day.? Apologies, HF, and thanks for inviting me; sorry to embarrass you.

Thinking About What Might Blow Up

Fascinating to see all of the markets that were going to blow up within 15 months trotted out for display.? Also, the basics of my theory on how one detects bubbles.

What Brings Maturity to a Market

Failure brings maturity to a market; risk-based pricing follows the realization of risk.

PIMCO in Theory and Practice

Important piece, because people watch PIMCO on the tube, and think that they make money off of their economic predictions, which are often wrong.? PIMCO is really a bunch of intelligent fixed income quants, who make their money off of mispriced out-of-the-money volatility.

Private Equity: Short Term versus Long Term Rationality

Analyzing comments of Cramer and others as to when the Private Equity bull market would end.

Speculation Gone Wrong, Or, Tops are a Process

I was commenting on how it is hard it is to call a top, because they are processes rather than events.? Who can tell how long foolish liquidity can last?

Trailing E/P as a Function of Treasury Yields and Corporate Spreads

Part one on my “Fed Model.”? Analyzing secondary factors in stock and bond performance.

Subprime Credit, Illiquidity, Leverage, Contagion and Concentration

I suggested that a small number of players would get hit by losses in subprime.? True enough, but what I did not know was how much risk was still being held by investment banks.

Efficient Markets Versus Adaptive Markets

A post I cite frequently, mainly for the joke at the end, but a post that tries to make the point that markets are not fully efficient, but they are somewhat efficient.

Quantitative Analysis is not Trivial ? The Case of PB-ROE

In some environments, PB-ROE and low P/E investing will be similar, but that will not always be true. Do not accept a false simplification, even though it may be true at present. The PB-ROE model is richer, and works in more environments, after adjusting for the limitations listed above. PB-ROE is a very useful tool, and not ?gobbledygook.?

Defends the PB-ROE model while admitting its limitations.

The ?Fed Model?

Defends a version of the dividend discount model, and shows the simplifications that the “Fed Model” imposes are unrealistic, while showing that a more realistic model can add value over the long run.

A Fundamental Approach to Technical Analysis

Tries to explain how an intelligent fundamental investor would think about technicals, particularly in markets that are less liquid.

Twenty-Five Ways to Reduce Investment Risk

This article got me an invite to write an article for a Canadian business magazine.? But this article encapsulates the many ways I think about risk in investing.

Dissent on Dividends

Roger Nusbaum ably pointed out how demographics favors an increasing amount of dividends being paid to retiring Baby Boomers.? That is true.? We have ETNs being set up to do that (beware of Bear Stearns default risk), and hedge fund-of-funds crowding into strategies that synthetically create yield.? Beyond that, we have Wall Street creating funky yield vehicles that gyp facilitate the yield needs of buyers (while handing them capital losses).

My main point is this.? Approach yield the way a businessman would.? If you see an above average yield, say 4% or higher, ask what conditions could lead them to lower the yield. History is replete with situations where companies paid handsome dividends for longer than was advisable.

Back in 2002, I heard Peter Bernstein give an excellent talk on the value of dividends to the Baltimore Security Analysts Society.? At the end, privately, many scoffed, but I thought he was on the right track.? I still like dividends, but I like businesses that grow in value yet more.? Aim for good returns in cash generating businesses, and the dividends will follow.? Stretching for dividends is as bad as stretching for yield on bonds.? That extra bit of yield can be poisonous, leading to capital losses far greater than the incremental yield obtained.

Dividends are good, but they are a very imperfect way to approach the market.

Is the S&P 500 30% undervalued?

A somewhat whimsical piece that looked at implied equity volatility alone, and suggested that either the equity market was low, or equity volatility was high.? The truth was neither.? Equity volatility would blow out and go higher still, along with credit spreads.? Fortunately I was not dogmatic about my model’s conclusions.? I was more bearish in general in late July.

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So much for that era.? It was an interesting time as the bubble neared its apex.

December 2010	January 2011	Comments
Information received since the Federal Open Market Committee met in November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.	Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions.	Shades their view of unemployment to include the phenomenon of discouraged workers.
Household spending is increasing at a moderate pace, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.	Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.	Shades their view of the consumer upward, but I fear for no good reason.
Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls.	Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls.	Shades their view on business spending up, but I think they are too early.
The housing sector continues to be depressed.	The housing sector continues to be depressed.	No change.
Longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward.	Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.	Notes the rise in commodity prices, and continues to misread both inflation and inflation expectations.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.	No change.
Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.	Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.	Translation: we have no idea why our policy is not working, and we don?t know what to do about it.? Monetary policy works with long and variable lags, so we won?t say that our policy isn?t working.? It?s just slow in taking effect.
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.	To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November.	No change.
The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.	In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.	No real change. They will stealth-fund the US Government to the tune of $600 Billion.
The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.	The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.	No change to this meaningless sentence. What? You would do otherwise?
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.	The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.	No change.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.	The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.	No change to this meaningless sentence. Would you do otherwise?? If we know that the opposite is impossible, why have the sentence at all?
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.	Changing of the guard with the regional Fed Presidents.
Voting against the policy was Thomas M. Hoenig. In light of the improving economy, Mr. Hoenig was concerned that a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.		No dissent.? Interesting because because many pundits speculated over how many would dissent, such as Kocherlakota, Plosser and Fisher.