Will The Fed Succeed?
I must have left you sitting on the edge of your chair, dear reader.
Last Thursday’s letter ended with a couple of provocative question marks: will Alan Greenspan become the most successful government employee since WWII?
Will the Fed, which has debased the currency it was supposed to protect, now turn out to be the savior of the economy it is supposed to ignore?
The Federal Reserve System was chartered to protect the nation’s money. This it has failed to do. Instead, it has acted like a security guard gone bad…sharing out the nation’s savings – rewarding debtors, bankers and bureaucrats at the expense of savers, pensioners and bondholders. It is robbery. But it is more subtle than taxation and it pays a lot better than sticking up cab drivers.
Fed officials don’t even have to worry about hailing cabs. They have a fleet of limousines to cart them from one price-rigging meeting to the next. Still, Fed officials were not satisfied with their lot.
Nowhere in the Federal Reserve enabling legislation is there any mention of a “chicken in every pot.” Nor is there any discussion of “protecting Wall Street’s commissions;” nor of “bailing out underwater businesses;” nor of “stimulating consumers to buy;” nor of “helping Americans go further into debt;” nor of “re-inflating leaky bubbles.”
Yet, those are the things the Fed now aims to do. Without ever taking white-out and pen to its public mission statement, nor appealing to Congress for authorization, the Federal Reserve System, under the management of former- Randite, goldbug Alan Greenspan, has expanded its mandate.
The dollar appears stable. Remarkably, against its main competitors, it has barely budged in the last six months. During that same time, consumer price inflation has risen – with energy costs hitting new highs and home prices rising as much as 1% per month in some areas. Gold, which unreliably clocks the pace of the dollar’s decline, has risen 14% against the greenback since April 2nd.
It’s not as if short term rates were unacceptably high at the end of last year. At 6%, subtracting the rate of consumer inflation, 3%, yielded a net real rate of return of 3% – about what real rates of return have averaged throughout the last century.
Still, rather than raise rates to head off what appears to be an increasing risk of inflation, Mr. Greenspan chose to lower them. Not gently. Not tentatively nor cautiously – but dramatically and aggressively.
Mr. Greenspan’s new focus may be found, according to Martin Wolf of the Financial Times, in the words he uses in his appearances before Congress. In his most recent three presentations, the guardian of the nation’s currency discussed money and credit not a single time. But he “mentioned productivity 42 times,” remarks Wolf.
Thus I come to the point of today’s letter which – I hope you won’t be disappointed – is yet another question: Does this expanded new role of the Fed’s presage a period of even greater neglect of its old one?
And another question: Is the dollar destined to fall – perhaps even in our lifetimes – at a faster rate, now that the Fed is no longer even pretending to protect it? To this latter question I offer a helpful response: I don’t know. But it seems like the sort of thing a prudent investor might want to protect himself against.
“The clear and present danger,” writes James Grant, “is that the chairman, being mortal, will miscalculate. It has happened before. Perhaps, he…has underestimated the strength and the persistence of domestic inflation.
“Perhaps, by overstimulating, the Fed will push bond yields and mortgage rates higher. Possibly, by perpetuating a belief in the Federal Reserve’s capacity to control essentially uncontrollable events, Greenspan will embolden American investors and precipitate even greater market losses.”
“The risk,” says Albert Friedberg, of Friedburg Mercantile Group, “is that external and internal inflation will begin eating away money, savings. There is an attack on both sides: the internal attack is already on, with the inflation rate in the U.S. creeping upwards and upwards, and the U.S. has been lucky because the dollar was strong and the dollar held down imported inflation. When the dollar now begins to weaken, I think that we will begin to see inflation get a little worse because external inflation will come in. You won’t want to sit through the dollar declining 15% or 20%, which is likely to happen in our view.”
Ian Campbell, writing for UPI, puts the risk a little higher. “Only the consumer,” he writes, “with cheap mortgage in pocket and array of credit cards in his hand, is keeping the economy going. Perhaps someone should tell him now is not the time to overspend. This is a crossroads for the world economy. The U.S. economy is going to head down further. And when the markets see evidence of that the Dow will fall again. In the next few weeks the euro is vulnerable to losing 3 more cents. In coming months the dollar could lose 30 cents.”
Neither gold, nor euro bonds, nor inflation-adjusted treasury notes (TIPS) have been the greatest investments over the last few years. Perhaps they will not be the greatest over the next few years either. But I doubt they will be the worst.
May 22, 2001
*** The Nasdaq is back! The index punctuated its fifth straight winning session with a 106-point advance. The Dow edged ahead a modest 36 points, as if to avoid stealing the limelight.
*** Typifying the Nasdaq rally, Cisco Systems attracted many admirers yesterday…just like old times. Investors, as if unable to tame their desires, had another fling with their former tech darling. Although lacking some of that youthful passion, the tryst was enrapturing nonetheless, as the stock soared more than 13% on the day.
*** It’s party time on Wall Street. “Fed’s welcome wagon is stocked with lots of bottles of champagne,” writes Ed Yardeni, “and the speculators are drinking the liquidity with gusto. The bubbly is bringing back irrationalexuberance fast.”
*** “One the best things about working on Wall Street are the ‘launch parties,'” grantsinvestor.com’s Eric J. Fry relates. “Last week, Krispy Kreme moved from NASDAQ to the Big Board, and to celebrate its matriculation into the highest echelon of stock trading, sponsored a launch party in front of the New York Stock Exchange. The ‘party’ occurred under a block-long tent on Broad Street where legions of smiling Krispy Kreme employees dispensed fresh donuts and coffee to everyone who passed by.
“Although utterly irrelevant to the investment process, launch parties have become de rigeur for any company listing on the exchange. Krispy Kreme claims to have given away 40,000 doughnuts in all. Mine was delicious.”
*** “Just how have speculative stocks been?” the Wall Street Journal asks. “The most speculative technology stocks rose 48.2% between April 4, when the NASDAQ Composite Index bottomed, and last Monday (May 14), according to numbers crunched by AQR Capital Management. The firm found that more-pedestrian tech names – those trading at less than 50 times their trailing 12-month earnings – were up 29.8% during the period, while non-tech stocks in the index returned 9.9%.”
*** The Nasdaq has now rebounded 41% from its April 4th low, while Cisco has soared an even more impressive 67%. One might imagine therefore, that both Cisco and the tech- laced index to which it belongs have nearly reclaimed their all-time highs. Not quite. Cisco has recouped barely one quarter of its record-high valuation. The Nasdaq has reclaimed less than half of its record levels.
*** In any given year, the stock market is more likely to go up than down. Why not just stay in stocks, buy the indexes, and forget about timing and stock selection? Would Mr. Market reward such a simpleminded approach? Would Mother Nature design a world in which the pleasure of rising stock prices always surpasses the pain of falling ones?
*** The Wall Street Journal provides an answer. In a story entitled, “Doing the Math: Tech Investors’ Road to Recovery is Long,” the Journal provided a long-overdue public service by explaining the widely misunderstood mathematical truth that recovering from a large loss requires large gains…very large gains.
*** For example, the Journal cites the Pro-Funds UltraOTC Fund, which fell a stunning 94.7% between March 2000 and the April 4th NASDAQ low. Since then, the fund has risen by a slightly greater percentage – 95.6%. “But at that point, an initial $10,000 was valued at just $1,035, still down 89.7% from its March 2000 level. To return to one’s original stake after a 95% tumble requires a 1,900% gain.” Yes, stocks usually go up…but when they fall the pain is especially sharp and deep.
*** And when stocks fall, newly impoverished novice investors seek to relieve the pain…pulling up to Wall Street curbs with lawyers-in-tow… USA Today introduced us to Cynthia McNamara who alleges that she lost $632,000 because her Merrill Lynch broker concentrated her assets in tech stocks and borrowed money on margin to make purchases. Cynthia tells USA Today, “If you had asked me what margin was a year ago I didn’t know. Now I know, but everything is gone.” Information is cheap. Knowledge is dear.
*** Stephen Roach, the bearish chief economist at Morgan Stanley Dean Witter & Co. remains unconvinced that the Fed rate cuts will prevent recession. “We went to excess in the late 1990s are many counts – investing in information technology, depleting personal savings, relying on foreign capital – and the overarching excess, the stock market bubble, capped off by the NASDAQ folly. At some point, you purge the excesses and revert to the norms, and that is generally triggered by recession.”
*** Gold yielded a little ground yesterday by “giving back” $2.00. However, most gold stocks finished on the plus side. Gold bottomed out at 255 (June contracts) on April 2nd. Since then, it has gained $37.
*** Remember Michael Martin? We quoted him in the Daily Reckoning as saying, “It wouldn’t surprise me to see gold jump out of here, up $15 to $20 in a single day.” Fresh from his prescient call, we just had to check back in with Mike to see if he wanted to tempt fate with a follow-up prediction.
*** “The best rally in two years leaves me paralyzed,” he says. “After 20 years of watching these rallies get snuffed out, I think caution is warranted short-term. But if you will allow me to hedge, I remain convinced that gold is in the process of beginning a long-term turnaround to the upside. I can safely predict, however, that it’s not going to happen in one day.”
*** The Blue Team has only been in business for a few weeks, but it already has a big win in its gold share recommendation. Franco Nevada is up 20%… Dover Corp., while not a gold, is up 11%…
*** No more Mickey Mouse investments for Warren Buffett. His Berkshire Hathaway sold the last of its Disney stock during the first quarter. Other notable recent sales by the sage of Omaha include Citigroup, Freddie Mac and General Dynamics.
*** While I was in Santa Fe, I stayed at Marriott’s Residence Inn. The accommodation was more like an efficiency apartment than a hotel room, designed for longer-term guests. Grants recently reviewed, favorably, a competitor in the extended stay market: Innkeepers U.S.A. or, to be more precise, Innkeepers U.S.A. Trust (KPA) an REIT. The company has 67 hotels, with 8,131 suites. It appears to be a good business, but the REIT, selling at a recent price of $10.26 per share, yields a dividend of an extraordinary 11.7%. ‘There must be a reason why this REIT is so cheap,’ I can almost hear you saying, dear reader. The thought occurred to me too. It turns out that 28% of the company’s revenue comes from properties in Silicon Valley.
*** Could the flood of income from Silicon Valley turn into a trickle this year or next? Yes, it could. But Sheila Stoltz, a fund manager with a stake in the company says “the thing about Innkeepers that’s particularly attractive is that they have a very strong balance sheet and they have a very high dividend, and a dividend that is easily covered.”