By Ron Muhlenkamp
It’s been an interesting summer.
Since 2008, the Federal Reserve (Fed) has been a huge manipulator of theand of interest rates. Beginning with (Troubled Relief Program) in 2008—and continuing through II (QE2), Operation Twist, and QE3, the Fed has added over $2 trillion to our (nearly $20,000 per household) and purposely bought U.S. Treasuries and mortgaged-backed to keep prices of these up and keep interest rates artificially low. The Fed first did this to avoid a financial meltdown in 2008-09 and continued it on the theory that it would help jumpstart the economy after the 2008-09 .
We believe thathelped avoid a financial meltdown. But we find it hard to find evidence that the subsequent QEs have helped to jumpstart the economy. We do think the QEs help support the bond and stock markets. But we also notice that Mario Draghi, President of the Central European Bank since November 2011, has had at least as much success supporting the European bond market without yet spending a euro.
We were told (and always believed) that the Fed wanted its manipulation to be temporary. Beginning in May 2013, market interest rates on U.S. Treasuries began to move up. By August 2013, theon the 10-year Treasury had climbed from 1.6% to 2.9 percent. Initially, this upmove in interest rates drove and ratios (P/Es) down, as one would expect; (see Chapter 4 of my book). But, by September 2013, stocks had recovered to their levels of May and had actually surpassed them. And the Fed began talking about a “tapering” in its purchases of Treasuries and mortgage-backed ; (currently at $85 billion per month or about $800 per household per month). In our judgment, the upmove in interest rates (from 1.6% to 2.9%) had brought rates near to where they would be without the Fed’s arm on the scale—and the had absorbed this increase very well. This presented the Fed with a great opportunity to “taper off” its manipulation.
On September 18, 2013, the Fed chose not to “taper.” For two hours,went up and some commentators celebrated; then, prices went down for five days as strategists (and I) tried to understand what the Fed’s (in)action meant for the markets going forward.
Having broached the topic of tapering in May, and having carefully shifted his tone in June, July, and August to calm investor fears of tapering, why did Ben Bernanke abandon those efforts in September by not executing the action he had so carefully prepared the markets for? My real fear is that the members of the Fed don’t want to taper, that they desire to continue to manipulate interest rates, or that they believe their continued manipulation as now essential to the operation of our economy.
If so, it will continue to complicate market evaluations of companies and their—with profitability and giving one set of values (refer to my book)—and interest rates giving another. The Fed’s legal mandate is to keep in check and to foster employment. Despite this, one of its current goals is to increase . Further, it is hard to find evidence that the Fed has increased employment. (Labor participation is the lowest it’s been since the 1970s.) But the Fed seems to have adopted increasing as a substitute for its mandate and is pointing to higher to justify keeping its whole arm (not just its thumb) on the scale of interest rates.
We’ve seen what happens when prices get ahead of the economy reality. The bubbles in the dot-com’s in 2000 and the housing market in 2007 were such effects. We fear that the apparent Fed desire to continue to manipulate interest rates may engender more bubbles.
The comments made by Ron Muhlenkamp in this commentary are opinions and are not intended to be investment advice or a forecast of future events.
Refer to the SMA All-Cap Value Fact Sheet for the Top 20 Holdings and performance data as of the most recent quarter-end.