On the eve of what may be the launch of the next big thing in monetary policy, we humbly ask: What have we learned this year?
One lesson is that while the future’s always unclear, clues about what’s coming are occasionally dispatched. Alas, those clues are often far more compelling in hindsight than they are in real time.
A case in point: Mr. Market snookered us back on June 13 of this year, when the 10-year Treasury yield briefly traded at 5.3%. Yes, that now looks pretty good when it’s lined up next to the 4.46% yield at Friday’s close. Back in June, your editor had an idea that something was bubbling in the credit markets, but we were less than convinced that buying 10-year Treasuries at a 5.3% was a no-brainer.
Three months later, it’s clear that we should have been leveraging ourselves to the hilt to snap up the now-obvious rich payouts guaranteed by our friends in Washington. Indeed, bonds have outperformed stocks handily in the last three months by a robust margin. The iShares Lehman Aggregate Bond ETF is up around 4% on a total return basis through Friday’s close from June 13 vs. a 1.5% loss for the S&P 500 Spider ETF.
So, what were we thinking in June? Or drinking? We were inclined to see the economic data as biased toward strength and so we thought rates might go higher, thereby raising questions about bonds. As it turned out, rates went lower, fueling a fixed-income rally.
Perhaps rates will go lower still. The Federal Reserve tomorrow is widely expected to lower Fed funds for the first time in four years. If so, might that trigger a fresh round of lower rates across the board?
While we ponder that one, consider what might happen if the Fed doesn’t cut. “It’s the most forecasted rate cut in history,” Gary Kaltbaum, president of Kaltbaum & Associates, told USA Today. “If they don’t cut, expect a 500-point drop [in the Dow Industrials] in minutes.”
Surely, Fed Chairman Bernanke’s aware of the market’s expectations and will act accordingly. Yes, but the debate is now over defining “accordingly.” The Fed head himself warned a few weeks ago that “It is not the responsibility of the Federal Reserve to protect lenders and investors from the consequences of their financial decisions.”
Into this mix comes the reality that while the U.S. economy appears to be slowing, global growth is still bubbling. The net result, according to BusinessWeek, is “Bernanke’s Dilemma.” One dismal scientist distills the dilemma this way: “We’ve been revising the growth forecast for the U.S. down, and up for the rest of the world,” Tim Condon, an ING in Singapore, told BW.
Risk is guaranteed for investors. Return is not. Over time, the only way to improve the latter is by mitigating the former and the tool of choice is diversifying across asset classes. Nothing reminds us of that more than a humbling experience at trying to second guessing the future. To which we might add: reminders are a constant presence in the investment universe.