29 January 2014 – The Aleph Blog

Redacted Version of the January 2014 FOMC Statement

Posted on 29 January 2014 by David Merkel

Comments

Small $10 B/month taper.? Equities flat and long bonds rise.? Commodities do nothing.? The FOMC says that any future change to policy is contingent on almost everything.
Shades their views of GDP household spending and business fixed investment up, and their views on labor force participation down.
They think that if they use more words, they will be clearer.? Longer statements are harder to parse and understand.? They need to clean up the statement.? There are many sentences that could be eliminated with no loss of meaning.
Current proposed policy is an exercise in wishful thinking.? Monetary policy does not work in reducing unemployment, and I think we should end the charade.
In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
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.
GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.

Book Review: The Safe Investor

Posted on 29 January 2014 by David Merkel

This is a special book.? It’s special because it explains investment concept in simple language, and tries to give average people an ability to understand how the markets work.

The author shares from his life experiences, where not everything turned out right.? With bonds in the 1970s, what was ordinarily a safe investment turned into “Certificates of Confiscation,” as inflation and interest rates rose.

The author is careful to point out the difference between fake diversification and true diversification.? False diversification has a large number of positions that are related, like owning many tech stocks from 1998-2003, or many financial and housing stocks 2005-2009.

True diversification means there is not some hidden factor that can affect your whole portfolio.? The author argues that we need a broad array of investments in the portfolio to diversify results, reducing volatility, so that the investment program can continue? until the target is reached.

Th author also argues? that investors need to dig into the guts of what they are investing in.? Who is the custodian?? Are my assets safe from commingling with the assets of others?? (Think of MF Global or Madoff.)? Is there any factor that could cause a substantial fraction of my assets to be significantly impaired?? As an example, what if you live to an old age?? Will you outlive your assets?? For most Baby Boomers, that is a significant risk that is under-appreciated.

The author, who managed two significant asset management firms in his career, encourages readers to do detailed checks on any active managers they hire (like me).? Analyze their methods, their incentives, their character, and more.? Passive investing does away with many of those questions, but still you have to set up an asset allocation.

As for active managers, they often buy and sell to make it look like they are doing something for clients, when frequently less activity would be in the best interests of clients.? Active management often works better at lower turnover rates.

Investment performance analysis has its own pathologies.? There is the need to buy an outperforming fund.? Why buy a fund that has done poorly?? An investor could ask two questions: 1) is the manager just benefiting from the current cycle, or are his picks good aside from that? 2) Has the manager gotten so large in that strategy that there is no place to place money to achieve an above average return.

The author also notes a strategy that many rich employ: hold safe assets and risky assets, but not the stuff in-between.? Few have made their wealth on the stuff in-between.? Preferred stock has made no one rich, nor investment-grade corporate bonds.? Junk bonds when carefully chosen may be an exception.

Now, that said, I think the author is too optimistic on emerging markets.? As in the current mini-crisis, many of them have immature financial systems, and are mis-financed.? Long assets are being financed by short loans.? This can goose growth in the short-run, but not in the long run.? I think that emerging markets have a place in portfolios, but smaller than the author implies.

Three Pockets

The author posits three pockets for assets — a large one for savings (don’t lose this), a medium one for investing (moderate risk), and a small one for trading (high risk).? He is trying to channel male actions in a good way.? You want to gamble?? Gamble with a small amount of money.? Keep the main body of your assets in ordinary hands that you do not touch.? Set it, and mostly, forget it.

This is an interesting way to try to get people to take limited risks, and have most of the portfolio be safe or have limited risks.

Passive vs Active

The author does not take a stark position on this, but points people toward passive funds if active fees are too high, and track records do not validate good investment choices.? That is how I feel about my own investing.? If I can’t outperform, I don’t want you investing with me.? The book’s position is only invest with active investors that have an edge.? That is more common with smaller cap stocks, international investing and junk bonds.

When to Adjust Portfolios to Reduce Risk from Aging

This book has risk positions lasting longer than most books, and generally, I think that is right, unless markets have gone to such high levels that intelligent investors should lighten up.? I think we are in one of those moments now.? Walk, don’t run, to reduce risk assets, and don’t go all the way, just lighten up.? I rarely make big moves, and the book would not advocate tactical big moves either.

I thought the book’s chapters on choosing advisors were well-written.? It gives you adequate ways to check out financial advisors like me, and those much larger than me.

Summary

The summaries at the end of each chapter are very useful.? I can endorse almost everything in the book.? Just be more careful about emerging markets than the book is, they have a lot of risk embedded at present.

Quibbles

None, aside from what what previously mentioned.

Who would benefit from this book: Most amateur investors could benefit from this great book.? If you want to, you can buy it here: The Safe Investor: How to Make Your Money Grow in a Volatile Global Economy.

Full disclosure: The PR people offered me a book, and I accepted it.? I am glad that I did.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

December 2013	January 2014	Comments
Information received since the Federal Open Market Committee met in October indicates that economic activity is expanding at a moderate pace.	Information received since the Federal Open Market Committee met in December indicates that growth in economic activity picked up in recent quarters.	Shades their view up, but I don?t see much to support it.? Most of the growth is inventories.
Labor market conditions have shown further improvement; the unemployment rate has declined but remains elevated.	Labor market indicators were mixed but on balance showed further improvement. The unemployment rate declined but remains elevated.	Shows less confidence as labor force participation falls.
Household spending and business fixed investment advanced, while the recovery in the housing sector slowed somewhat in recent months.	Household spending and business fixed investment advanced more quickly in recent months, while the recovery in the housing sector slowed somewhat.	Shades their views of household spending and business fixed investment up.
Fiscal policy is restraining economic growth, although the extent of restraint may be diminishing.	Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.	No change.? Funny that they don?t call their tapering a ?restraint.?
Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.	Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.	No change.? TIPS are showing slightly lower inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.54%, down 0.10% from December.? Treasuries have rallied versus TIPS since the emerging markets crashed partially due to the taper.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate.	The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate.	No change. ?Monetary policy is omnipotent on the asset side, right?
The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced.	The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced.	No change.
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.	The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.	No change.? CPI is at 1.5% now, yoy.
Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee sees the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.	Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.	No change.? They have a deficient model of what deficit spending does for the economy.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases. Beginning in January, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $35 billion per month rather than $40 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $40 billion per month rather than $45 billion per month.	In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in February, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month.	Reduces the purchase rate by $5 billion each on Treasuries and MBS
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.	The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.	No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.	The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.	No change.? But it has little impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.	The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.	No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.	If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.	Says that purchases will likely continue to decline if the economy continues to improve.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.	However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.	No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.	To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.	No change.
The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.	The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.	Not a time limit but economic limits from inflation and employment. Just ran the calculation ? TIPS implied forward inflation one year forward for one year ? i.e., a rough forecast for 2015, is currently 1.80%, up 8 bps since the last meeting.? Here?s the graph.? The FOMC has less than 1% of margin in their calculation.
In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.	In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.	No change.
The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.	The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.	No change. Repetitive.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.	When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.	No change.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Charles L. Evans; Esther L. George; Jerome H. Powell; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Richard W. Fisher; Narayana Kocherlakota; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen.	The names change, but the vote is largely the same ? why no hawks urging for a faster end to QE?
Voting against the action was Eric S. Rosengren, who believes that, with the unemployment rate still elevated and the inflation rate well below the target, changes in the purchase program are premature until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate.		Rosengren is no longer a voting member.? Good.