THE FEDERAL RESERVE (The Fed) MATTERS
The Fed is a private institution owned by its' members. The best book written on the introduction of the Fed is "The Creature from Jekyll Island". Read the book, it's in the library waiting for you.
This post is not to prove that the Fed is a "good" Institution or a "bad" Institution, its a post to prove the Fed matters.
The Fed issue the Federal Reserve notes that we call "currency" of the USA. they don't specifically control the "value" versus other currencies as that is apparently for the Treasury Dept. Either way you get the point that when it comes to dollars and cents the Fed matters. Now, given we know the Fed are important to the currency, it only goes to show that you need dollars to buy stocks and stuff, like commodities! Commodities are priced in dollars, as are the stocks in the USA. So the Fed matters again.
The other interesting point to make about the Fed is the dual mandate of price-stability and full employment. As you see the Fed matters.
Here is where it gets interesting, in order to fulfil both mandates, the Fed has the ability to lower and raise interest rates for the US. Now, there are several ways to measure interest rates: Fed Funds, 10yr Treasury yields and 2yr Note yields. For the sake of ease we are going to stick with Fed Funds as the point of reference.
When the Fed LOWER rates, you can assume that the economy in the US needs some help with easier monetary policy.
When the Fed RAISES rates, you can assume that the economy in the US needs a little cooling down with higher rates.
That's the basics then.
Here is where it gets really interesting when it comes to stocks and commodities and the dollar: WHEN THE FED CHANGES STANCE, THERE IS A RE-PRICE OF EVERYTHING PRICED IN DOLLARS!
I can not stress that enough.
FOMC dates matter!!
There are several reasons, the most important is the "risk-free rate of return" changes.This particular number is without a doubt the most important number to learn, it prices just about everything!
So when the Fed moves its' stance you can expect everything to change price, however insignificantly.
1994
Back in 1994, after a diffcult period that started with the 1987 stock market crash and ran through an S&L crisis on the way to RTC, the Fed raised rates. What happened?
The Bond market re-priced. The article link will explain all.With the bond market re-price equities naturally lost some value. There are several theories behind why, the most obvious to me was positioning of assets. The peak to trough for stocks amounted to 10% of value. Not a disaster as long as you were prepared for the reaction. The lesson was to be prepared for the action and buy the panic that ensued. A healthy stock market would discount the worst possible news it could and quickly.
The following few months in the stock market caused many to fear for growth as rates would go higher crimping the conomy. This did not happen. The rally of 1995 was eye-watering and incredibly difficult to stay on. The rally from 1996-1999 was legendary with pockets of chaos.
1994 and the FOMC...
2004
The same type of action followed in 2004. A 2000-2002 market melt-down started by the Internet bubble, through Sept 2001 and into a recession and military action of 2002. In the October of 2002 the US and Allies embarked on Military action in Afghanistan. This actually marked a low for stocks in the US. "Buy to the sound of guns, sell to the sound of trumpets" as a good friend once remarked, was quite apt at that point.
The Fed started to raise rates in 2004, only this time stocks had prepared for a move previously, still the peak to trough for equites was around 10%!! The following rally in stocks in 2005-7 led to the housing bubble and subsequent Financial crisis.
(You just cant make those numbers up! 10% peak to trough! So similar to 1994 that you have to re-check the numbers.)
2013 and 2014
We are now in December 2013 and looking forward to 2014. The Fed are expected to change stance again, the question is when? This time the FED have enacted a policy of Quantitative Easing. It amounts to the same thing as easing. So using the previous two episodes for when the Fed moves, you can assume IT MATTERS.
What to expect:
Risk-free rate of return to change.
10yr bonds re-price
2yr notes re-price
Dollar strengthens (it already has significantly)
Commodities suffer (they already have)
Equities, peak to trough, could well be -10%.
What to do?
Be prepared for equity markets to discount further moves from the Fed and therefore price QE to zero quickly. It will look like the end of the world, it isn't. Trying to time the exact top and the exact bottom is likely fruitless, no matter how hard one tries.
The US is expanding its' economy and when that happens, everything else looks a little better for the majority of people. That is a good thing no matter what your politics are.
Enjoying bull markets is as important as playing them....
In a nutshell, buying panic is very difficult, but rewarding. Be prepared, do not panic. We will price the worst outcome quickly, subsequent news will be discounted. Position size is important, any position that doesnt allow you to sleep is the wrong size.....just ask Mum!
Queen takes Pawn
