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Are We Witnessing a Melt-Up In Long-Term Bonds?

By Ben Carlson, A Wealth of Common Sense

Since the financial crisis, investors are constantly on edge that we’ll see another melt-down in the stock market. On the other hand, there are investors such as Jeremy Grantham of GMO, that have been predicting the opposite — a melt-up in stocks before we see an eventual crash as investors notoriously take things too far.

But what if investors are looking for a melt-up in the wrong place? What if the real melt-up is already occuring in one the most boring asset class of all — long-term U.S. treasuries?

Long bonds have been on fire this year as they’re currently one of the best investments of any asset class. The iShares 20+ Year Treasury ETF (TLT) is up over 28%. From a historical standpoint, were that number to hold up through year end, it would be one of the best years ever for long bonds. Here are the top ten annual returns going back to 1926:

LT-bonds-I1

The performance in 2014 cracks the top five highest of all-time.You’ll notice that every single result in the top ten has occured since 1982 when interest rates started their steady decline from double digit levels. The average yield during these best performing periods was nearly 7%, juicing the total returns.

It seems everyone expects yields to shoot higher eventually, but I wanted to see what the performance numbers looked like in the past when rates stayed low for a long period. From 1926 to 1960, long bond yields were basically stuck in the 2-4% range. The current yield is in that range so historical returns could offer an idea about future performance. These were the ten best annual returns from that previous low yielding period:

LT-bonds-II

This lower-for-longer period of interest rates led to a much more muted upside. The average return of the ten highest years in the 1926-1960 time frame was around 10% versus an average of 27% for the ten best in the 1926-2014 period.

Long bonds have shown fairly decent returns over the very long-term, going all the way back to 1926, of 5.7% annually (2.8% on an inflation-adjusted basis). But from 1926 to 1960 they only returned 3.2% a year (1.8% after inflation). This is not a prediction, just something to be aware of when setting return expectations.

People have been predicting the demise of bonds and a rise in interest rates for a number of years now. Anything is possible, but rates don’t have to go up just because they did in the past. There are legitimate reasons that we could see rates continue to fall in 2015 and beyond which could mean long bonds outperform once again. If we really were in the melt-up phase that’s exactly what would happen.

However, were this trend in rates to reverse, it’s worth noting that treasury bonds don’t see huge crashes like stocks do because of the way they’re structured (see: What Does the Bursting of a Bond “Bubble” Look Like). The largest annual loss in long bonds was only around 15% in nominal terms. Inflation is the real long-term killer of bonds.

So if you’re looking for a melt-up in 2015, it’s quite possible it could be in bonds and not stocks as most people assume.

Further Reading:
What’s an investor to do about bonds?
Looking beyond interest rate risk in bonds
Back-testing the Tony Robbins All-Weather Portfolio

Quick Thoughts on the Fed Statement

Not much to say here following the latest Fed statement. They dropped “considerable time” and added that they will remain “patient”. I don’t even know what that means, but the parsing of words here is a bit overdone in my opinion. The key point at present is not in the statement’s specific terminology, but the broader macro events. And at present the Federal Reserve and other Central Banks are seeing a few things:

  • Very tepid global growth & declining growth in many international markets.
  • High risk of deflation in Europe.
  • Growing risk of contagion from the collapse in oil prices and the Russian economy.
  • Low wage growth and downside risks increasing in the US economy.
  • Increasing risk of banking system defaults due to oil and foreign exposure.
  • An economy that is still healing from the impact of the financial crisis.

Given all of this there is simply no way that Central Banks can consider tightening. Frankly, I am shocked by how shocked people are about this report. This announcement was a total no-brainer given recent events. So, the bottom line is:

  • The Fed is on hold at least until Q3 next year.
  • In Q4 2015 and Q1 2016 the inflation comps will get rather low which will make the Fed much more skittish.
  • I still think there is a high risk that we will be at 0% interest rates when we enter the next recession.
  • Therefore, QE is the likely policy tool of choice. Any dovish statement should be interpreted as a move towards an increasing probability of balance sheet expansion.

Chart of the Day: Hello Deflation?

I mentioned earlier this week that the inflation threat is totally off the table in the near-term thanks to the collapse in oil prices.  And we now have a great idea of just how much the decline in oil prices is impacting prices. The PriceStats Daily Developed Markets Index follows prices in the USA, Canada, Japan, Australia, the United Kingdom and Europe.  And it’s telling us a very grim story (via Josh Zumbrun at WSJ):

BPP

My guess is we’ll see a snap back at some point in late 2015 as the year over year comps become very low, but for the near-term there is very clearly no threat of inflation.  And that means that any Fed tightening is going to be put on the back burner.

Update:

Here’s another view of this that might be helpful in terms of putting this in some historical perspective. The 10 year break-even rate which shows inflation expectations has now declined to levels that we haven’t seen since 2010:

breakevens

 

Oaktree’s Marks on Russia: If you put your $ in the bank will you get it back?

Some good stuff here from Howard Marks of Oaktree.  I particularly liked his view on asset price declines where he says “declines are not a reason to get worried. Declines are a reason to get excited.  The investing public likes things better at high prices than at low prices. The professional investor likes things better at low prices than at high prices.”  There’s some generalization going on there, but I think that’s a very good underlying principle to always remember.  It’s sort of the old Warren Buffet saying “eat like a whale when no one else is eating and eat like a shrimp when everyone else is eating”.  Actually, I just made that up because that’s just what I do at dinner time, but nevermind. You get the point.

More via Bloomberg TV:

Howard Marks, co-chairman of Oaktree Capital Management, told Bloomberg Television’s Stephanie Ruhle and Matt Miller today that loose rule of law is a major concern for investors who are considering buying assets in Russia. Marks said: “In order to make investments, you have to believe that you will benefit from the rule of law…The underlying question about Russia is whether you will. The question is, if you put your money in the bank will you get it back in the end?”

Marks also said that he is “working on a memo…about the lessons of oil. And one of the lessons that we’re learning again now is how fast things can change in the investment world…now all of a sudden a few months into this oil slide that has evaporated and in some corners we’re seeing panic. Weak deals that could get done because the markets were complacent and generous now are being exposed as having been overleveraged, et cetera. So of course when that happens we go from being extremely reticent to being aggressive.”

Video: http://bloom.bg/1BUeSED
Full transcript below.

 

MATT MILLER, BLOOMBERG: I want to talk more about what’s going on overseas, the currency there, the interest rate aspect of it, which I find fascinating, the investment play. Let’s bring in Howard Marks right now. He’s our co-host for the hour. He’s the co-chairman of Oaktree Capital Management, which has $93 billion under management. He’s using the plunge in crude prices to buy up energy company debt, which would be the most interesting thing we could talk to him about today except for the fact that the central bank in Russia did this. Howard, what does it say to you that you can make 17 percent on your money right now? Are you sending it all to Moscow?

 

HOWARD MARKS, CO-CHAIRMAN, OAKTREE CAPITAL: I think that in order to make investments you have to believe that you will benefit from the rule of law. And the underlying question about Russia is whether you will. You (inaudible) used the expression a minute ago, he’ll steal it.

 

The question is if you put your money in the bank to make 17 percent, which sounds like a lot of money, will you get it back at the end? We like to make investments where the range of outcomes is from here to here. In Russia the range of outcomes is probably from here to here.

 

STEPHANIE RUHLE, BLOOMBERG: Is that because you simply can’t trust the rule of law?

 

MARKS: That’s one of the most important reasons. That’s right. And does — will Russia according — operate according to international norms?

 

MILLER: So you have to assume that Vladimir Putin knows this. Even if he’s unpredictable he’s an intelligent, educated, thinking man. Why would he —

 

MARKS: And thus he would never invade another country and (inaudible).

 

MILLER: Well exactly.

 

RUHLE: Ding, ding, ding, ding.

 

MILLER: Well unless he thinks that he has the right to do it and that it’s somehow by birthright his country. He might also think that he has the right to take $20 billion from Yukos and Mikhail Khodorkovsky and throw him in jail for a decade. He might think that he can do these kind of things without repercussion. So is this going to change his mind?

 

MARKS: Well and in fact what your correspondent just said is that he remains extremely popular. The popular masses in many countries like to see the leader behaving powerfully, especially when the country has been suffering economically. It’s a great distraction from economic suffering to operate strongly nationalistically.

 

RUHLE: All right. Well if not in Russia let’s talk about where you do see opportunity right now, these falling energy prices, oil.

 

MARKS: Well the — it may not surprise you, Stephanie, to know that I’m working on a memo. And it’ll be not about oil, but it will be about the lessons of oil. And one of the lessons that we’re learning again now is how fast things can change in the investment world. There was an economic philosopher, Rudiger Dornbusch, who said it takes a lot longer for things to happen than you think that it can, but then they happen much faster than you thought they would. And that’s the way things go in the investment world.

 

For a couple years now I’ve been visiting you. We’ve been talking about a high level of confidence and complacency. And now all of a sudden a few months into this oil slide that is — has evaporated and in some corners we’re seeing panic. Deals that — weak deals that could get done because the markets were complacent and generous now are being exposed as having been overleveraged, et cetera. So of course when that happens we go from being extremely reticent to being aggressive. It has —

 

MILLER: Do you not see — so for the ruble for example there may be no floor, right? But for oil there is definitely a floor.

 

MARKS: And that is, Matt?

 

MILLER: Zero.

 

MARKS: Okay.

 

MILLER: But I’m just saying do you see a slightly higher level here, for example $50, something where you’re feeling fairly confident oil is not going to be cheaper than that?

 

MARKS: Well you can’t say. You can say that, but then you —

 

MILLER: Or will stay cheap.

 

MARKS: — quickly have to retract it. In ’80 people probably said, well it couldn’t go below $70.

 

MILLER: Yes.

 

MARKS: And now at $60 people say it couldn’t go below $50.

 

MILLER: Right.

 

MARKS: We’ve talked about gold. Gold is kind of similar to oil in many ways. It’s hard to put a price on gold, or on oil or on any other asset which is not income producing. We can say what a bond is worth because we say it in terms of its income, ditto for a stock, a P/E ratio, but for an asset that doesn’t produce cash it’s hard to say what a fair price is or a price that can’t be exceeded on the downside.

 

RUHLE: So where does the opportunity set lie? When people look at oil prices falling, how should they view it?

 

MARKS: Well I guess having said what I said, in deference to Matt’s comment, there is some point at which you have to say it’s probably not going to go lower. And if you can buy the bonds of a company which became over levered because the capital markets were too accommodative at a price in which you’ll do okay if oil goes to $35 you probably should step up and do it, especially when other people are selling. My favorite cartoon I think was from the ’60s, has the Stephanie Ruhle of the day in front of the TV reading his script. And he says, everything that was good yesterday is bad today. And that’s the way markets go. And there’s analytical and then there’s emotional. And when panic takes over and markets stop being discerning that’s the time for the bargain hunter to get active.

 

RUHLE: Are we reaching that point, because six months ago everybody loved the credit markets, everybody loved high yield, forgetting that it’s called junk for a reason. Is this a moment when we should start getting worried about that asset class?

 

MARKS: I don’t think — I would turn it around.

 

RUHLE: Well you’re distressed, and so you like it.

 

MARKS: I’d say we should start getting interested in the asset class. Declines are not a reason to get worried. Declines are a reason to get excited. The investing public like things better at high prices than at low prices. The professionals like things better at low prices than at high prices.

 

MILLER: Now let me ask you.

 

RUHLE: Hold on, one more time. Say that one more time because it’s such a good point.

 

MARKS: Well the public, people who and who don’t understand how investing works like things, feel better at things when they’re at high prices, and lose confidence as the price falls. Warren Buffett says, I like hamburgers and I eat more of them when they go on sale. The investment professional who understands the intrinsic value of the things he’s looking at, hopefully, likes things better when the price converges to or falls below the intrinsic value.

 

MILLER: You want to buy when there’s blood on the streets. Let me ask you about that in mind, Jay Wintrob, you recently brought him in as CEO of Oaktree. And he’s trying to attract more money from insurers. He came from an AIG unit that managed obviously the insurers’ money. And they sent some of it, less than five percent to private equity and hedge funds, but you want to now as one of those investment places attract more of that kind of capital. How can you do that?

 

MARKS: Well Oaktree has had an investment, insurance company clientele for many years. We want to increase that. We’ve been doing that. It is not one of Jay’s principle mandates to do that. His mandate is to apply professional management. Oaktree has been stuck with me and with —

 

RUHLE: Stuck. Oaktree has been stuck with Howard.

 

MILLER: And been blessed with you.

 

MARKS: And with my partner, Bruce Karsh, neither of us are professional managers. We hopefully we’re good investors. Then we had John Frank as managing principal, who was and very good at minding the store, but he’s not a professional manager. He’s a lawyer. Now we’ve brought in somebody we’ve known for over 30 years who has real bona fide he’s as a professional manager. And when you get to 1,000 people in 20 businesses with almost $100 billion under management I think it’s time to have professional management.

 

RUHLE: Have you learned something different now that you’re offering products for retail investors? When I think about Howard Marks I feel like you really hone in on the psychology of investing. Have you learned anything different about how retail investors like to invest?

 

MARKS: Well what I believe I’ve learned over my years in this business is that the best service we can provide the retail investor is education, is to make him understand what we’re doing, and why and thus what he should do about it, and convince him not to invest, make investment decisions emotionally.

 

RUHLE: And in 2015 if there’s one lesson you can teach, what do you want it to be in terms of investing?

 

MARKS: I can’t say one, well to have reasonable expectations and to like things better as the prices fall.

 

RUHLE: Oil.

 

MILLER: Yes.

 

RUHLE: Stop crying about oil. Listen to Howard.

 

MILLER: Very interesting. Can we keep him for the hour?

 

RUHLE: I would love it if he would stay. Howard, thank you.

 

MILLER: Howard Marks, always a pleasure.

History is an Outline, not a Blueprint of the Future

One of the most important points I stress in my book is the importance of thinking about market environments as their own unique set of circumstances. In the world of finance and economics it’s always convenient to look at the past and draw conclusions about the future. We’re seeing this quite a bit in the current environment where Russia appears to be undergoing a currency crisis and many people are drawing their conclusions based on the 1998 experience. And while there are many similarities (falling oil prices, collapsing exchange rate, etc) there are also many differences (floating exchange rates, significant foreign reserve positions, etc).

The important point is that this cycle is not like the 1998 cycle. It’s different and it has its own unique causes and effects. Yet we see this sort of historical backtesting in all corners of the finance and econ world. It’s so convenient to extrapolate the past into the future in your portfolio construction or your economic forecasting because that makes us feel confident about our projections. But the reality is that no one really knows precisely how the future will play out and the future is certain to be different than the past to some degree. The best we can do is study the history, view it as an outline, understand the current environment and monetary system for what it is and put together the best blueprint of the future that we can.

So yes, it’s important to arm yourself for the future by studying the past, but we must also understand that our necessary forecasting of the future relies on more than understanding market history.

 

Lessons Learned in 2014

By Seth Masters, AllianceBernstein

In 2014, US stocks forged ahead, international developed and emerging-market stocks lagged, bonds did better than expected, and the IRS took a bigger bite. Here are some lessons for US investors to carry forward into 2015.

Lesson 1: The US Market Keeps on Ticking

Geopolitical crises were in the headlines throughout 2014: the threat from ISIS in Syria and Iraq, tensions between Russia and Ukraine, fighting in Gaza, the Ebola epidemic in West Africa, slower growth in China, and economic stagnation in both the Eurozone and Japan. Yet the US equity market still motored ahead.

We are living in a global economy. If the rest of the world is struggling, can US companies continue to prosper?

In the medium term, the answer could be yes. The US is still in the early stages of a cyclical expansion, and we think the overall growth rate will be supported by key trends among consumers, governments, and companies. US consumers paid down debt after the financial crisis and are now beginning to spend again—cautiously. Similarly, US federal and local governments pared back during the immediate post-crisis years, and they are now able to increase their budgets. Finally, US companies are gaining market share globally, and US manufacturing is now undergoing something of a renaissance. We think that these trends could continue for a while and that they are positive for US stockholders.

It would be a serious mistake to think that the US market is invulnerable, but it would be just as erroneous to underestimate its resiliency.

Lesson 2:  Diversification Means Owning Laggards

After leading globally in 2013, in 2014 through November the US stock market beat developed international stock markets by 15.5 percentage points in US dollar terms; it beat emerging markets by 11.5 percentage points, as shown in the first Display, below. This outperformance by US stocks has some investors ready to throw in the towel on global investing.

Masters_Lessons-Learned_display-1_d2

We think selling an asset after a stretch of lagging performance is a bad decision. Often, the lagging asset may be more attractive looking ahead. And that’s what we’re seeing in developed international stocks markets, where valuations are more attractive than in the US stock market.

Since 1990, non-US stock markets have outperformed the US market more than half the time. Since no one can be certain just when this will occur, we think it’s wise to own stocks in all regions.

A similar argument can be made for diversification by size. Large-cap US stocks trounced small- and mid-caps by 8.4 percentage points so far in 2014, but large-caps trailed smaller stocks by 11.7 percentage points annualized from 2001 through 2003. The key is to hold stocks across the size spectrum.

Diversification remains a fundamental tenet of smart investing—both as a way to manage risk and as a way to maximize return.

Lesson 3: Eat Your Bonds—They’re Good for You!

High-quality intermediate bonds in a portfolio serve, above all, as a counterweight to stocks. When stock values tumble, bond values typically rise and help to offset the declines. As the second Display, below, shows, when the stock market dipped from mid-September to mid-October, a 60% stock/40% bond portfolio gave investors a smoother ride than an all-stock portfolio—smooth enough that some might have stayed in the market rather than fleeing in fear.

Masters_Lessons-Learned_display-2_d2

Of course, investors also like the income bonds provide. And through November 2014, core bond strategies delivered about 4% in total return—less than bonds have returned over the past 30 years, but a bit above the 3.5% we project for them over the next 30 years.

Don’t neglect bonds. Even with today’s lower yields, they can help you sleep at night. Investors should have enough bonds on their plate to be confident they will be able to withstand the next market downturn—whenever it happens.

Lesson 4: If You’re Afraid to Invest, Dollar-Cost Average

In 2014, too many investors sat on the sidelines in cash, convinced that they’d missed the bull run and afraid that if they invested now, the market would soon tumble and afflict them with buyer’s remorse.

Dollar-cost averaging can reduce the odds of experiencing these painful regrets. Our research shows that investing all at once has historically been the more effective approach, as shown in the third Display,below. But if the market turns volatile, dollar-cost averaging can help to dampen the effects. If stocks fall right after your first purchase, you’ll take a hit, but you’ll also be able to buy your next installment at a lower price. If you average into the market within a limited period of time—say six months or a year—you’ll likely be better off than if you’d stayed on the sidelines.

Masters_Lessons-Learned_display-3_d2

You can think of dollar-cost averaging as a kind of regret insurance. Beyond this emotional benefit, the key advantage is that it gets you to your strategic asset allocation target, albeit after a delay. Like all insurance, dollar-cost averaging has a price—lower returns, typically, during the period of averaging in. But the longer-term benefits of being fully invested can outweigh this cost.

Lesson 5: Be Tax Savvy

In April 2014, taxpayers in the top bracket saw their final 2013 tax bills at new, higher rates. There may be further unpleasant surprises ahead for the 2014 tax year. The rising stock market has left investors with few or no remaining capital loss carryforwards, so to rebalance or spend from their portfolios, they have to realize capital gains. Smart strategies can help minimize the resulting tax bills that will arrive next year.

There are two ways to reduce taxes: avoidance and deferral. Avoidance permanently eliminates or reduces a tax, while deferral puts off payment into a later tax year. Avoidance is worth more to your bottom line.

By diligently tracking and timing trades, you can ensure that capital gains will be long-term and dividends will be qualified. This permanently reduces the rates at which they are taxed.

Another way to avoid taxes in the current year is through charitable contributions. Cash gifts avoid taxes by creating a tax deduction, but savvy taxpayers can further avoid tax by giving appreciated securities, thereby also eliminating an embedded capital gain. Additional techniques, such as converting a traditional IRA to a Roth IRA and contributing to a 529 plan, can provide tax benefits further into the future.

While not as valuable, tax deferral can also help reduce the current year tax bill. First, to the extent you can defer taking gains until after January 1, you can delay the tax hit. Next, volatility could create an opportunity. If the price of a stock falls below your basis in it, you can harvest the loss to reduce your tax bill in the current year. Some investors seized this opportunity in mid-October, but rising stock markets since then have limited loss harvesting opportunities for the remainder of 2014.

You also can defer taxes by making larger contributions to retirement vehicles such as 401(k), IRA, and Keogh plans. Timing is important: In a rising market, making contributions early next year can help you shelter more growth over the course of 2015.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

The views expressed herein do not constitute and should not be considered to be, legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation. 

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.

Seth J. Masters is Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.

Can a Central Bank Always Create Inflation?

Ambrose Evans-Pritchard got a Paul Krugman lashing over the weekend thanks to some comments about the power of Central Banks when the economy is stuck at the zero lower bound.  Evans-Pritchard had argued that increasing the money supply is still a relevant strategy for increasing inflation and Paul Krugman didn’t agree based on the evidence of the last 5 years which has put king sized holes in the idea that “money printing” QE can create inflation.

Ambrose responded today making some rather strong claims that I don’t think are exactly right. This isn’t the first time I’ve been critical of his commentary. Back in 2009 Ambrose wrote a piece about a potential bubble in US government bonds and I responded with a lengthy piece citing the many reasons why I didn’t think US Interest rates would rise, why bonds weren’t in a bubble, why there was no risk of US solvency, why we weren’t like Greece, why there was no hyperinflation coming and why high inflation certainly wasn’t coming. All of this led me to believe that there was most certainly not a bond bubble in US government bonds and that view has been undeniably correct.

It’s important to be precise in these discussions because the details are what help us understand cause and effect. I start from a very in-depth understanding of the monetary system and its institutions and apply specific monetary environments to my thinking. It’s by no means perfect, but it’s generated some fairly good results over the last 5 years.

Anyhow, Ambrose says in his piece:

“Central banks can always create inflation if they try hard enough. As Milton Friedman said, they can print bundles of notes and drop from them helicopters. The modern variant might be a $100,000 electronic transfer into the bank account of every citizen. That would most assuredly create inflation.”

Central Banks are not omnipotent independent entities.  They are essentially just normal banks with loose legal constraints and a central infrastructure. But they are still constrained by the laws in the system in which they operate. For instance, the Federal Reserve is not legally allowed to just transfer $100,000 in the bank account of every citizen. The Fed must operate within the laws that constrain their actions as outlined in the Federal Reserve Act. And the Fed “transfers” money into private bank accounts by buying other private sector assets. This is the key weakness in QE’s inflationary transmission mechanism. As I’ve described tirelessly, QE swaps private sector financial assets. It does not create more net financial assets. It’s madness to think that swapping a checking account for a savings account will lead to higher inflation. So Ambrose is not describing a realistic transmission mechanism.

Ambrose then goes on to argue that monetary policy that “finances” the deficit could be inflationary. I don’t necessarily disagree with this, but that is not monetary policy. The size of the Federal deficit is not determined by the Federal Reserve so they can “finance” the deficit as much as they want, but they are merely playing second fiddle to the US Congress.  Again, the Fed is not the institution in control there.

He later argues that the key to QE being inflationary is to buy assets from non-banks.  That’s been happening in droves in the USA with no inflationary effects. Again, this was a mere asset swap of privately held T-bonds for deposits with the banks acting as middlemen. I described this in some detail here. But he goes on to say:

“The relevant monetarist prescription is to buy assets from non-banks. The authorities do not have to purchase state bonds (though to do so is convenient, politically neutral, and easily reversible). They could equally create and inject money by buying land, or herds of Texas Longhorn cattle. Central banks can buy anything they want, and it should be obvious that the effects of buying cattle do not work through the rate of interest.”

Again, the Federal Reserve has no authority to purchase cattle or land. But yes, if they did this would most certainly be inflationary. I’ve referred to this idea as “Roche’s Bags-O-Dirt” in the past. That is, if the Fed could buy worthless bags of dirt from the private sector at $100,000 a pop that would most certainly cause inflation for obvious reasons. But again, we have to understand the world for what it is and not what our monetary theories want it to be. And buying bags of dirt, cattle or land just isn’t on the legally mandated list of assets that the Fed can (or will) buy.

If we fail to understand our monetary system for what it is, as opposed to what economic myths say it is, then we come to all sorts of generalized, vague and erroneous conclusions. Of course, all Central Banks are somewhat different in how they’re structured and so the details matter in terms of how powerful they really are within a certain economy, country and legal structure, but in the developed world economies there are important constraints on these entities that limit exactly how powerful they are.  I hate to pile on here, but I think Krugman is generally right – given the limited policy tools that Central Banks have and their unwillingness to utilize more controversial tools I just don’t see how there’s a currently relevant transmission mechanism by which Central Banks can be relied upon to carry the policy burden.  So while economic theory is correct that a Central Bank can always create inflation, the reality is generally much more complex.

Related:

 

A Lesson in Market Crashes

By Ben Carlson, A Wealth of Common Sense

Be fearful when others are greedy and greedy when others are fearful. So easy to say but much harder to pull off in real-time.

The reason?

People can always become greedier or more fearful. Case in point — the Russian stock market. In early March, MarketWatch columnist Brett Arends laid out the case for investing in Russian stocks, specifically Russian small caps:

Heaven help me, I’m going to invest in Russia.

I’m not going to overthink it. I’m not going to let people talk me out of it. I am going to throw some of my money into the Russian stock market—and then forget about it for a few years.

The riskier the stocks, the better. The investment of choice looks like the MarketVectors Small Cap Russia exchange-traded fund (RSXJ), which holds stakes in about 30 small Russian companies. The fees are 0.71%.

Arends went on to show that Russian stocks were down nearly 60% from their all-time highs in 2008 at that time, while the small caps were down nearly 80% from their peak in 2007. The problem with huge losses is that it requires even larger losses to move the needle even further.

In his piece Arends showed that Russian small caps were down 78% as of the beginning of March from the all-time highs. Since then, they’ve dropped another 40%. That stings. But in the grand scheme of things that only drops the cumulative total loss to 87% in total. As the numbers approach zero (hopefully the stock market of the 8th largest economy in the world doesn’t make it that far) you need a much bigger drop to add to the total loss. So a 40% loss only added another 10% or so to the bottom line since 2007.

To go from an 80% loss to a 90% loss requires another 50% in losses.

Unfortunately, when trying to catch a falling knife, timing can be everything. Which is why it probably makes sense for most people to either stay away from these types of speculative investments or dollar cost average over time with an established time horizon measuring many, many years.

I’m not trying to single out Arends for a wrong move here. He had legitimate reasons for taking the plunge into Russian stocks. If you read his reasons for investing in Russia, nothing has really changed all the much, except for the fact that the stocks have fallen that much further.

His thesis could still be proven out as long as he can hold his nose for a few years (or decades). The lesson here is that falling markets can always fall further than you imagine just like rising markets (see: stocks, U.S.) can stay strong for longer than most realize.

Source:
Why I’m going to invest in the Russian stock market (QZ)