The Dividend Cafe - Yellen Does Some Yelling

Episode Date: September 21, 2017

Yellen Does Some Yelling by The Bahnsen Group

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. I'm David Bonson, Managing Partner and Chief Investment Officer at the Bonson Group. And we are really excited to come to you this week with yet another summary of markets and what we're looking at in our positioning for the portfolios we manage on behalf of our clients. I think it's been a very interesting week in that more than any point in at least a year and a half, maybe two years now, we see a sort of resurgence of conversation around the Federal Reserve, central banking, and a desire to kind of connect dots to understand what various policy decisions may impact capital markets and how they may do so. And of course, central banking and monetary policy have always had that impact, but they were so primary after the financial crisis. They were such a major driver through three different rounds of quantitative easing, of quantitative easing through an extended period of zero interest rates, that it was natural for the Fed to be a very dominant driver of conversation in financial media

and in the punditry class. But the political environment really sort of relegated them to second or third page. As we got into the very fascinating primary on both sides of the aisle in early 2016 and all the way through the election and obviously after the reasonably surprising election of President Trump and then now well into the different iterations of how this first eight or nine months of his presidency has gone and expectations around policy achievements and deregulation and all of these sorts of fiscal pieces and policy pieces that's driven the day in terms of what people have conversed about.

And central banking activity has taken kind of a backseat. But I really think that right now we are going to be in for a little period where that may be different. There was no shock to anyone on Wednesday. The Fed did announce they were not raising rates this month. on Wednesday. The Fed did announce they were not raising rates this month, but Chairwoman Yellen in her press conference was rather adamant for those sort of reading through the language that they do expect another rate increase in December. Our Fed funds futures market was pricing in just over a 30% chance that they would raise rates in their December meeting just a month ago. And that number had kind of creeped back up around 50%. And then as we talk right now,

the market is showing well over a 70% likelihood. So that projection, that telegraphing of their intentions is very important. We are of the school of thought that they are highly unlikely to make major monetary actions, take monetary actions apart from telegraphing to the market. And what we see going on right now certainly counts as such. Not a very significant deal, but again, another quarter point in the overnight federal funds rate. But then she spent more time talking about their intentions with their balance sheet. The Fed has added $4 trillion to their balance sheet by buying bonds, primarily treasury bonds, but a significant amount of mortgage-backed securities as well

and they of course did so through three rounds of quantitative easing wherein they bought these bonds with money that didn't exist ramping up the excess reserves in the banking system and more important than anything else, driving or attempting to drive interest rates down. So they have said that they intend to peel back some of this balance sheet excess and we're getting more and more details. For one thing, they have no intention of selling these bonds off whatsoever. Even next month when they will begin some of this, they're only talking about what's called roll off. About taking bonds that they own, that mature, and with those proceeds, not reinvesting them. Not buying more bonds. So sort of extinguishing through time

those assets on the balance sheet. It is in any way, shape or form a direction towards tightening. It is normalization, but it is so unbelievably tame and slow that it's really hard to gauge what, if any, impact there may be. Markets have largely not moved since the announcement came out. Interest rates moved up a little bit, but they're still way lower than they were earlier in the year. Stock prices are basically completely flat. So there wasn't a big surprise to the news. But the comment I want to make for those of you listening to this podcast is that the Fed has set their own target of a 2% inflation rate. I don't happen to agree with it. I don't believe central bankers should be seeking to

create price inflation. But by any standard, the Fed does not believe that they've achieved their own target, that inflation level is significantly lower than the 2%. And yet, the three things that Chairwoman Yellen very clearly said yesterday were, A, we are targeting 2% inflation. B, our model tells us it should be happening. And then some, because they are using what's called the Phillips curve model that projects rising inflation being a byproduct of this very low unemployment rate. And then C, her concession that this Phillips curve is not modeling correctly right now. Now, the difference is they believe the model will be vindicated. So therefore, they want to create policy in line with what they think should be happening

or will be happening, not what they see happening now. I happen to believe the Phillips curve is a bunch of bunk and the bulk of the economists that I hold in high regard agree with me. But these are very ideological central bankers and they're very committed to what they their model centric view of economics i don't believe that they're ill-intentioned but i do believe they're wrong however what they're talking what i'm talking about they mean wrong is in the reason for why they would be doing what they're doing or not doing what they're doing i happen to agree that some degree of very mild and modest normalization is needed lest we distort risk pricing in the capital markets. Let me say it differently. Lest we end up creating false signals, malinvestment, encouraging poor decisions as a result of a bad price signal that interest rates being heavily manipulated represent.

Fundamentally, I believe the Fed is going to tighten, but barely at all, because they're still held in place by a very low demand for money and a very low velocity of money and very low yields in the highly debt deflationary economies of both Europe and Japan. So the low interest rate environment of our global friends keeps us from being able to allow our own monetary paradigm to expand much. So while it may seem like there's a lot to chew on there, there's a number of things going on. You've got to read some of the charts that I have at

DividendCafe.com this week because it shows you the dollar having declined 10% on the year, despite this concept of the Fed reducing balance sheet and preparing to raise rates nominally. We see how much the stock market flattened when the Fed's balance sheet began to flatten. And yet the balance sheet has stayed flat and the stock market has taken a completely another leg up over these last 18 months. So there's a lot of data that sort of contradicts a lot of narratives, and yet narratives abound. And my suggestion and my encouragement for clients, for investors,

is to understand that this is uncharted water, that we have never been in a position of unwinding the type of monetary policy we're about to unwind. And that not only is predicting exactly what the Fed will do darn near impossible, but predicting how the market will respond to what the Fed does is utterly impossible. And therefore subject to all sorts of error and fallibility. So we continue to believe that there is some great opportunity in the market.

We prefer to lean more defensively So we continue to believe that there is some great opportunity in the market. We prefer to lean more defensively just simply based on the valuations. And we absolutely recommend an active approach wherein one has the discernment and discretion to avoid some of the frothier parts of the market and to not depend on the Federal Reserve doing X or doing Y or the reaction to X or Y being a certain way in the market, all of which is subject to incredible surprise and even contrarian response. So I'm very excited for what we're doing in our client portfolios. I'm excited to be out in New York at the end of next week with my investment solutions managing director, Nadea Parnas, as we prepare for dozens of meetings with leading portfolio managers, hedge funds, and market strategists

to further delve into our thinking and our investment worldview right now, to challenge a lot of our own presuppositions and see what actionable decisions may be in order. That's where we're going to be a week from now. But right now, another reasonably quiet week in markets and changing of the guard and a lot of the conversation driver. The Fed is back and I don't know if it relieves some of the White House and media hysteria around a lot of those things. It might be nice for a while. But I'm going to leave it there for the week. Have a wonderful weekend. Thank you for listening to the Dividend Cafe podcast. Thank you for listening to the Dividend Cafe, financial food for thought.

The Bonson Group is registered with Hightower Securities, LLC, member FINRA, MSRB, and SIPC, and with Hightower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research

is provided as general market commentary. It does not constitute investment advice. The team in Hightower shall not in any way be liable for claims and make no express or implied representation or warranties as the accuracy or completeness of the data and other information or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the team and do not represent those of Hightower Advisors LLC or any of its affiliates.