Never Say Never!

Richard Croft
November 19, 2012
6 minutes read

In October 2010 I penned the following comments: there has “never” been a market anywhere anytime that didn’t revel in the prospect of easy money! Which is to say: one should never fight the Fed.

At that time, most of the industrialized world was engaging in massive stimulus programs designed to keep economies from falling into a deflationary spiral with an ancillary goal of trying to stimulate employment.

Now two years later we are doing more of the same. Certainly global markets are higher than they were in October 2010 which tacitly supports the “don’t-fight-the-Fed” line of reasoning. But constantly throwing money at any problem eventually becomes a game of diminishing returns. The question is when do diminishing returns manifest themselves in the financial markets.

I posited in the same October 2010 article that “there was no reason to believe [stimulus] efforts would work any more effectively [then] than they did [in the first quarter of 2009].” What we got then and now are short-term spikes in equity markets, increased volatility among commodity stocks, a weaker US dollar, an increase in protectionist sentiment and uncertainty as to whether the three branches of the US government can come together on anything.

Despite the obvious fallout central banks seem more than willing to engage in further fiscal stimulus. The successes of earlier programs that were set in motion to “save the financial system” have made it easier for central banks to engage in more of the same. To the point where in some cases, they have assumed the role of governments that cannot seem to find a balance between actionable deficit reduction strategies and political survival.

That the US Fed is even talking about another round of stimulus – in addition to their unlimited bond buying program – implies that they are preparing for fallout from the fiscal cliff. Whether it ends up being a worst case scenario or, more likely, a scenario in which a lame duck Congress and the President push it off until sometime later in 2013. Either scenario does nothing to ease investor angst or drive stock values higher.

The takeaway is that the financial markets are prepared for the “kick-the-can-down-the-road” scenario. The surprise would be an agreement that balances revenue and tax cuts while providing a blueprint for deficit reduction. If we were able to remove that uncertainty it would set the stage for a significant rally which is probably why stocks have remained in a relatively tight trading range despite so much uncertainty.

That said, the elephant in the room is the buildup of public debt which has the potential to raise borrowing costs some point down the road. That particular debt elephant is making itself at home in the Finance and Treasury departments of governments around the world, with only a few exceptions. Think Greece and you get a small taste of the kind of havoc that elephant can wreak. It’s not a pretty sight.

Coming full circle it strikes me that further stimulus by the US Fed may cross the diminishing return line. I say that because the current malaise has more to do with consumers who are trying to “de-leverage.” A technocratic term for paying off debt instead of borrowing and spending wildly, as puzzled Keynesian economists believe consumers should be doing in a near-zero interest rate environment.

In a deleveraging environment money center banks are sitting on stacks of cash trying to find qualified borrowers. The qualified borrower is the only game in town for banks that are slowly becoming acclimatized to a regulatory regime with new rules on risk levels and capital ratios. Little wonder the lending pendulum has swung from “Wild Bill” to “Honest John” in the blink of an eye which may be positive for the longer term, but short term unless those stacks of cash get into the hands of consumers there will be no positive impact on the economy.

Same story with big businesses (i.e. those big name global companies domiciled in North America) who are also sitting on stacks of cash, unwilling to expand plant, equipment, staff, or R&D budgets in the face of massively intrusive and troublingly vague financial, healthcare, and environmental legislation.

So it’s left to central banks to flood the market with liquidity in an increasingly desperate effort to get something – anything – moving. But the notion that markets will continue to revel in easy money seems less likely. At a minimum the term “never” may be too strong a point of view.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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