In August, 2006, I wrote an article titled, “B is for Bernanke”. This was an arbitrary grade that I awarded the Federal Reserve Chairman for his first six months on the job. With the passing of his second anniversary, I thought it might be worthwhile to revisit his performance.
In retrospect, the article was printed at the cusp of a changing interest rate cycle. The Fed under Ben Bernanke (BB) had just finished the tightening cycle (a total of 17 hikes started under Greenspan) that were intended to control inflation. Rising interest rates were indeed the necessary antidote to the real estate bubble sweeping the country, but like all cycles, the timing is rarely perfect and the outcomes of bubbles are never tidy. With the benefit of hindsight, it appears that the Fed waited too long to drop interest rates and as a result, the US economy is now on the precipice of at least a major slowdown, or even a recession.
If I had written this article at the end of 2007, I would have dropped BB’s grade from a B to a C-minus. From August to early December, I, along with many other investors, started to lose confidence in BB and for good reason. Bernanke’s central bank was slow to understand the broader implications of the housing-induced credit malaise and therefore was slow to respond. Even worse, Fed rhetoric from the various governors was uninspiring, confusing and divergent at times, all of which sowed the seeds of the market’s discontent.
My worries started to diminish when the Fed (in coordination with other central banks) implemented an original and effective way to help ease the global credit crunch. The Term Auction Facility (TAF) was a program in which the Fed auctions term funds to depository institutions—in essence, the TAF allowed the Fed to inject liquidity into the system that had come to come to a grinding halt. BB followed up the introduction of TAF with 125 basis points (1.25%) of fed funds rate cuts in January, which means that the Fed has returned to aggressive easing. Unfortunately, one of the unintended consequences of the Fed’s “surprise” moves is that they contribute to an already-volatile market.
Many believe that BB’s actions came too late. According to a survey conducted by the Wall Street Journal, economists are “faulting him [Bernanke] for what they said was his poor management of Fed communications and being overly attentive to fluctuations in the stock market. The overall grade they gave Mr. Bernanke dropped below 80 for the first time.”
My personal grade for BB is C+, with hopes that it will rise as BB continues to improve his performance on the job. Of course, now that Bernanke is acting in a more traditional manner, that means that the central bankers are likely to overshoot rate cuts, keep rates lower for longer to ensure economic recovery, potentially creating another asset bubble, but that’s a discussion for a future performance review!
Friday, February 8, 2008
Thursday, February 7, 2008
Year of the Rat
Today is Chinese New Year 4706, the Year of the Rat. A rat may seem kind of gross, but it holds a place of honor in the Chinese lunar calendar, because it is the first creature in the 12-year cycle. Legend has it that the rat was the first one to arrive when Buddha summoned 12 animals to name a year in each cycle after each one of them. With global markets in turmoil, I conducted some quick research about Chinese New Year and the symbolism associated with the Rat to help provide some much-needed guidance for, if you excuse the pun, rattled investors.
According to legend, a Rat Year is a time of hard work, activity, and renewal. As the US economy slows to a crawl and maybe into recession, the idea of renewal was particularly interesting to me. While making a fresh start is appealing, the lore also warns that the rewards may not be immediate. A new job, relationship, business venture, or even an economic recovery begun in the Year of the Rat may not yield fast returns, but opportunities will come for people who are well prepared and resourceful. The best way for you to succeed is to be patient, let things develop slowly, and make the most of every opening you can find.
How can you be well-prepared? Start with another Chinese New Year tradition: clean your entire house. In your financial life, that means reviewing all aspects of your wealth management plan, especially your approach to your portfolio. Is it time to sweep away your nonchalant management style or your unresponsive broker who only calls when there is a product to sell? The clarity that can arise from putting old “buy and hold” strategies in the trash could be freeing and allow you to prepare for the coming opportunities that the Year of the Rat will present.
On a more basic level, Rats are considered cunning and thrifty, with the ability to save for rainy days. Considering that the rain is already coming down in our economy, the Rat is an ideal model---a great money saver, who in tough times knows how to make something out of nothing or how to make things advantageous for himself.
Finally, one of the symbols of the New Year is to pass out red packets called Lai See Hong Bao (or Hongbao) with money tucked inside to provide good luck. The packets are a great metaphor for “paying yourself first” to help you achieve financial good fortune. The Chinese believe that the amount should be an even number as odd numbers are regarded as unlucky—we can live with either an even or odd number if it means saving more. Gung Hey Fat Choy! (Wishing You Prosperity and Wealth!)
According to legend, a Rat Year is a time of hard work, activity, and renewal. As the US economy slows to a crawl and maybe into recession, the idea of renewal was particularly interesting to me. While making a fresh start is appealing, the lore also warns that the rewards may not be immediate. A new job, relationship, business venture, or even an economic recovery begun in the Year of the Rat may not yield fast returns, but opportunities will come for people who are well prepared and resourceful. The best way for you to succeed is to be patient, let things develop slowly, and make the most of every opening you can find.
How can you be well-prepared? Start with another Chinese New Year tradition: clean your entire house. In your financial life, that means reviewing all aspects of your wealth management plan, especially your approach to your portfolio. Is it time to sweep away your nonchalant management style or your unresponsive broker who only calls when there is a product to sell? The clarity that can arise from putting old “buy and hold” strategies in the trash could be freeing and allow you to prepare for the coming opportunities that the Year of the Rat will present.
On a more basic level, Rats are considered cunning and thrifty, with the ability to save for rainy days. Considering that the rain is already coming down in our economy, the Rat is an ideal model---a great money saver, who in tough times knows how to make something out of nothing or how to make things advantageous for himself.
Finally, one of the symbols of the New Year is to pass out red packets called Lai See Hong Bao (or Hongbao) with money tucked inside to provide good luck. The packets are a great metaphor for “paying yourself first” to help you achieve financial good fortune. The Chinese believe that the amount should be an even number as odd numbers are regarded as unlucky—we can live with either an even or odd number if it means saving more. Gung Hey Fat Choy! (Wishing You Prosperity and Wealth!)
Wednesday, February 6, 2008
Recession Obsession
The US economy is slowing and we may be in or heading towards a recession. OK, you already knew that, but it seems like every time we get a piece of data that confirms it, investors sell stocks and become obsessed with the notion of recession. That’s what happened yesterday.
The Institute for Supply Management (ISM) released its findings earlier than scheduled amid concern that this important data may have gotten into the public domain --- is anyone else flashing back to the leaked crop report in “Trading Places”? The ISM reported that the U.S. service sector contracted for the first time since March 2003 in January. The ISM's services index came in at 41.9, versus 54.4 for December -- far lower than the forecast 52.5. Any reading below 50 indicates contraction, which obviously would indicate a slowing economy.
Investors hate negative surprises and usually react to them by selling stocks. Each of the 30 stocks that make up the Dow Jones Industrial Average fell as the index lost 370.03 points, or 2.9%, to 12,265.13. It was the worst single-day performance of the year in both point and percentage terms. Year to date, the Dow is down 7.5% and is 13.5% below the high it touched on Oct. 9 of last year. The S&P 500 dropped 44.18, or 3.2%, to 1336.64, is now down 9% on the year and 15% below its October high. The Nasdaq Composite Index fell 73.28 to 2309.57, a decline of 3.1%, leaving it 19% below its October peak and down 13% year to date.
With data telling us that the economy is slowing, hearing the Richmond Fed President Jeffrey Lacker say that “the risks [of recession] have risen lately," does not seem particularly enlightening. Still, many commentators attributed some of yesterday’s selling to these comments. Lacker noted that more interest-rate cuts might be needed to tackle risks to growth -- but also acknowledged concerns about inflation – again, this is information that we already know.
So where does that leave us as we enter a new trading day? Clearly the US economy faces a turbulent time ahead, with a housing market mired in a recession; tighter financial conditions; and potential spillover of the credit crisis into other areas of the economy. Before you find yourself in a full blown recession-obsession, remember that the combination of monetary and fiscal stimulus should help steady the ship and eventually lift the economy. And of course, it’s never as bad or as good as you think it is.
The Institute for Supply Management (ISM) released its findings earlier than scheduled amid concern that this important data may have gotten into the public domain --- is anyone else flashing back to the leaked crop report in “Trading Places”? The ISM reported that the U.S. service sector contracted for the first time since March 2003 in January. The ISM's services index came in at 41.9, versus 54.4 for December -- far lower than the forecast 52.5. Any reading below 50 indicates contraction, which obviously would indicate a slowing economy.
Investors hate negative surprises and usually react to them by selling stocks. Each of the 30 stocks that make up the Dow Jones Industrial Average fell as the index lost 370.03 points, or 2.9%, to 12,265.13. It was the worst single-day performance of the year in both point and percentage terms. Year to date, the Dow is down 7.5% and is 13.5% below the high it touched on Oct. 9 of last year. The S&P 500 dropped 44.18, or 3.2%, to 1336.64, is now down 9% on the year and 15% below its October high. The Nasdaq Composite Index fell 73.28 to 2309.57, a decline of 3.1%, leaving it 19% below its October peak and down 13% year to date.
With data telling us that the economy is slowing, hearing the Richmond Fed President Jeffrey Lacker say that “the risks [of recession] have risen lately," does not seem particularly enlightening. Still, many commentators attributed some of yesterday’s selling to these comments. Lacker noted that more interest-rate cuts might be needed to tackle risks to growth -- but also acknowledged concerns about inflation – again, this is information that we already know.
So where does that leave us as we enter a new trading day? Clearly the US economy faces a turbulent time ahead, with a housing market mired in a recession; tighter financial conditions; and potential spillover of the credit crisis into other areas of the economy. Before you find yourself in a full blown recession-obsession, remember that the combination of monetary and fiscal stimulus should help steady the ship and eventually lift the economy. And of course, it’s never as bad or as good as you think it is.
Monday, February 4, 2008
Super Week
The week is not half-way over and already it is indeed SUPER. The Super Bowl reminded even the most ardent Patriots fans that like markets, sometimes the most improbable of circumstances can combine to create an outcome that defies expectations. (To read more about this topic, get a copy of Nassim Nicholas Taleb’s book, “The Black Swan: The Impact of the Highly Improbable.”) In the end, it is always helpful to remember that unexpected events with extreme impact are nearly impossible to predict, despite our desire to explain them in retrospect.
This is also a handy nugget to keep in the back of your mind as we kick off Super Tuesday today on the campaign trail. The lengthy primary season has seen the focus shift from war to experience to electability and now, to use the famous James Carville term, “It’s the economy, stupid!” American voters are feeling blue about how they are doing and many have wondered, “Which party/candidate would be best to help us get back on more solid footing?”
In fact, I have been asked repeatedly to make a case for a Republican or a Democrat win based on economic policy, but it’s not that easy. Conventional wisdom says that Republicans reduce taxes and spending, while Democrats increase them. As a result, investors have long thought that a Republican win is better for their portfolios—that is until they take a look at President Bush’s two terms. Yes, there were tax cuts, but they came with a historic amount of spending. That’s not just his fault—after all, he needed Congress to get the party started.
But like the unexpected outcome of the Super Bowl, data debunks the Republican/Democrat market expectations. On average since 1901, the stock market had performed better (in both nominal and real terms) when a Democrat was president than when a Republican sat in the oval office. Republicans are quick to point out that this result was due to the inclusion of the Hoover and Roosevelt presidencies which included times of extreme duress. That being said, sometimes it is hard to predict how a candidate will act once he or she is in the Oval Office.
Considering that the margin between the two parties is so small, voting based on past performance would seem like just as bad a predictor with regard to election outcome as assuming that simply because the Patriots won 18 games that they would win the Super Bowl. But while we are on the topic of football, I can’t forget to include one more inane bit of data for our Super Week: the Super Bowl Indicator (SBI).
According to the SBI, a Super Bowl win for a team from the old AFL (AFC division—the New England Patriots in this year’s contest) foretells a decline in the stock market for the coming year, and that a win for a team from the old NFL (NFC division—the New York Giants) means the stock market will be up for the year. Amazingly, the predictor has been correct 80% of the time. So here is a soothing note for Patriots fans: maybe your team’s loss will be a boon to your portfolio!
This is also a handy nugget to keep in the back of your mind as we kick off Super Tuesday today on the campaign trail. The lengthy primary season has seen the focus shift from war to experience to electability and now, to use the famous James Carville term, “It’s the economy, stupid!” American voters are feeling blue about how they are doing and many have wondered, “Which party/candidate would be best to help us get back on more solid footing?”
In fact, I have been asked repeatedly to make a case for a Republican or a Democrat win based on economic policy, but it’s not that easy. Conventional wisdom says that Republicans reduce taxes and spending, while Democrats increase them. As a result, investors have long thought that a Republican win is better for their portfolios—that is until they take a look at President Bush’s two terms. Yes, there were tax cuts, but they came with a historic amount of spending. That’s not just his fault—after all, he needed Congress to get the party started.
But like the unexpected outcome of the Super Bowl, data debunks the Republican/Democrat market expectations. On average since 1901, the stock market had performed better (in both nominal and real terms) when a Democrat was president than when a Republican sat in the oval office. Republicans are quick to point out that this result was due to the inclusion of the Hoover and Roosevelt presidencies which included times of extreme duress. That being said, sometimes it is hard to predict how a candidate will act once he or she is in the Oval Office.
Considering that the margin between the two parties is so small, voting based on past performance would seem like just as bad a predictor with regard to election outcome as assuming that simply because the Patriots won 18 games that they would win the Super Bowl. But while we are on the topic of football, I can’t forget to include one more inane bit of data for our Super Week: the Super Bowl Indicator (SBI).
According to the SBI, a Super Bowl win for a team from the old AFL (AFC division—the New England Patriots in this year’s contest) foretells a decline in the stock market for the coming year, and that a win for a team from the old NFL (NFC division—the New York Giants) means the stock market will be up for the year. Amazingly, the predictor has been correct 80% of the time. So here is a soothing note for Patriots fans: maybe your team’s loss will be a boon to your portfolio!
Mr. Head Honcho
I was fortunate to hear a Wall Street legend speak last week. This is a guy who has forty plus years in the business and now leads one of the country’s largest banks. I was struck by his absolute charming demeanor and more importantly, by his humility. Because it was a private event, for the purposes of this article, I will call him “Mr. Head Honcho” or “HH”.
In talking about the current environment, HH noted that in all of his years in the industry, this is has been by far the most challenging environment that he has faced. Considering that he has guided his firm through every major crisis, including the crash of 1987, the Asian crisis, the collapse of LTCM, 9-11, the dot-com crash, it was an amazing statement. However, it was his candid description of the subprime crisis and its explosion and reverberation that struck a chord in me. Many of us have wondered how some of the best and brightest titans of the financial services industry could have been nailed so badly by what was essentially one bad trading idea. The answer was fascinating and one from which we can all learn.
Mr. HH described how the smartest analytical folks in his firm talked about a strategy, which was essentially the purchase of subprime notes, packaged, sliced and diced and a corresponding hedging strategy that would protect the initial position. There were detailed flip charts highlighting the mathematical models supporting the idea. HH said that he recalled that one of the engineers of the strategy noted that statistically, the risk level was quite low. In fact, it would take “a-once-in-a-lifetime series of events to blow up the trade.”
Of course we now know that the “once-in-a-lifetime series of events” not only blew up the trade, it cost the firm and many like it, billions of dollars. HH paused and looked at us and said, “you know, just because we are professionals in this business does not mean that we can not become blinded by the numbers. What I really learned in this crisis was that it is imperative that any investor who is about to make a decision understand the true risk involved—to ask, ‘what am I doing here? What if the worst case scenario occurred…is the outsized loss, even though statistically unlikely, worth the upside?’”
HH smiled and noted that one of the reasons that he loves this business is that nobody can be right all the time and that it forces him to keep learning. “Markets humble us every day and when you forget that fact, I can promise you that your next hard lesson is just around the corner.”
In talking about the current environment, HH noted that in all of his years in the industry, this is has been by far the most challenging environment that he has faced. Considering that he has guided his firm through every major crisis, including the crash of 1987, the Asian crisis, the collapse of LTCM, 9-11, the dot-com crash, it was an amazing statement. However, it was his candid description of the subprime crisis and its explosion and reverberation that struck a chord in me. Many of us have wondered how some of the best and brightest titans of the financial services industry could have been nailed so badly by what was essentially one bad trading idea. The answer was fascinating and one from which we can all learn.
Mr. HH described how the smartest analytical folks in his firm talked about a strategy, which was essentially the purchase of subprime notes, packaged, sliced and diced and a corresponding hedging strategy that would protect the initial position. There were detailed flip charts highlighting the mathematical models supporting the idea. HH said that he recalled that one of the engineers of the strategy noted that statistically, the risk level was quite low. In fact, it would take “a-once-in-a-lifetime series of events to blow up the trade.”
Of course we now know that the “once-in-a-lifetime series of events” not only blew up the trade, it cost the firm and many like it, billions of dollars. HH paused and looked at us and said, “you know, just because we are professionals in this business does not mean that we can not become blinded by the numbers. What I really learned in this crisis was that it is imperative that any investor who is about to make a decision understand the true risk involved—to ask, ‘what am I doing here? What if the worst case scenario occurred…is the outsized loss, even though statistically unlikely, worth the upside?’”
HH smiled and noted that one of the reasons that he loves this business is that nobody can be right all the time and that it forces him to keep learning. “Markets humble us every day and when you forget that fact, I can promise you that your next hard lesson is just around the corner.”
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