Earlier this month, we took to Twitter using #askMI2 for our first live Q&A featuring Harry Melandri. This is the first of many sessions designed to give you direct access to our team of specialists.
This month we covered
The Federal Reserve’s current activities
Viable stock options
For those that missed it – we’ve captured all the insights here!
What exactly is the Fed up to?
During the session, Harry fielded a question relating to the reaction function of the Fed.
What do we know for sure? The minutes from the last Fed meeting confirmed the view that they are absolutely committed to fighting deflation. No conditions, no ifs, no buts. Even if deflation does not actually show up in the end. Whilst combatting deflation minimizes the risk of repeating the policy mistakes that led to the Great Depression, it’s still a risky strategy for long-term economic stability. It’s probably why break-evens have been creeping up despite 10% unemployment rates and other COVID nasties.
The worry here is what the Fed can, and will, do if the buyers don’t show up for long end auctions. The same meeting minutes show us that Reserve would like more time to think about yield curve control (YCC). This involves targeting a longer-term interest rate by a central bank, rather than buying and selling as many bonds as necessary to hit that rate target. They also hint that the Federal Open Market Committee (FOMC) isn’t going to be writing blank checks forever. Rates will stay low unless markets look too frothy.
What are the implications of getting HYG on the market?
For years we have talked about the “Greenspan Put” or the “Bernanke Put”. Now the Chair of the Federal Reserve (J Powell) has taken policy response to financial crises to the next level. Effectively selling the finance theory equivalent of puts to investors. Of course, one of the joys of this is the Fed is literally picking winners and losers. If you are a fan of capitalism, which functions by rewarding success and punishing failure, this might worry you a little.
Keep an eye on the Fed’s movements. They are now the third biggest owner of the iShares iBoxx $ High Yield Corp (HYG) stock. According to Bloomberg, only Bank of America and Fisher Asset Management own more shares than the central bank but give it time.
Where do we go from here?
The Fed’s interest-rate cuts have done little to stop the stock market crash. As such, there’s a good chance of a lopsided recovery; slow output growth with accelerating prices, and inflation. In other words, stagflation. The pressures of stagflation – both in the US and elsewhere – are high.
You could argue that the entire developed world is walking down the same path Japan took in 1989. Too much private-sector debt will do that. We’re also tipping over into a demographic deflation in much of the developed world. If nothing were to change, we would be in a world of deflationary pain.
Viable stock options right now
A question came through about whether the aviation and tourism sectors are viable stock options given prices are still relatively low. Whilst it’s a speculative ask, Harry’s view is “a good speccy bet beats a bad investment” any day of the week – provided you respect stops.
That said, airlines as an example have always been tough investments; hyper cyclical, and very easy to get wrong. Buffet has lost money in them – twice – and he is a more experienced investor than most. Even looking at US airlines, whilst they are too big to fail, they are very unlikely to be a great investment. Paul Tudor Jones recommends finding the “fastest horse” and “riding” that one i.e. the strongest stock. It’s very hard to believe that the airlines are going to be the “fastest horse”. What’s more, continued government bail-outs across the globe mean airline stocks will never fully wash-out.
Just starting out?
The single most critical piece of advice for new investors just starting out. It’s not what you don’t know that will kill you, it’s what you think you know. Don’t risk everything on what you think you know.
Trade with stops or diversify. Limit risk. Make sure you know you will be around next week. Losing is never fun but losing more than you can afford can be disastrous.