If you have followed this blog, or read Financial Bull Riding, you’ll know that the stock market tends to follow the business cycle and Fed monetary policy determines the business cycle for the most part. So I was very interested to read this title: "Voices: SteveKrawick, on Asset Allocation Guided by Fed Policy." Krawick wrote
“There are four phases in a Fed cycle. Today we're in the fourth and final phase of the cycle that began around 2008. This phase is marked by an accommodating Fed, which means low interest rates. Historically, in this environment, consumer discretionary stocks and financials have outperformed S&P benchmarks and their peer sectors. So, during this cycle, we have our clients overweight in that sector and underweight in others like industrials, materials, and technologies, which tend to underperform under current conditions.”
This advice meshes well with what the Austrian business-cycle theory would recommend. Investors should get out of cycle stocks, that is, those in the capital equipment industries and tech stocks near the end of the expansion and into consumer goods stocks, which are considered defensive or secular stocks.
However, I have a little trouble with this:
“Soon though, we'll be transitioning from the fourth phase of the Fed cycle to first, which will likely mean a gradual tightening in the Fed's policy structure. This shift will happen when the Fed raises the funds rate. As we make that transition, the consumer discretionary sector will fade and those industrials, materials, and technologies that are underperforming now will become the clear winners.”
Krawick is right that usually at this point in the business cycle the Fed begins to raise rates, but I’m afraid this time may be different. The Fed raises rates in order to squelch inflation. But the prospects of inflation are dim. Remember that
has suffered low rates for 30 years with almost no inflation. Japan
Hayek and Mises hoped for a day when businessmen would not let the banks fool them into borrowing only to suffer in the bust. That may partly explain why businessmen refuse to cooperate today by borrowing and investing. Instead, they’re sitting on mountains of cash. Another explanation may be that taxes and regulations make investing in the
unattractive. A third explanation may be that consumers are sending dollars
overseas by buying imports and sending investments overseas to emerging markets. US
may be in for a long period of low growth, low inflation and very low interest
rates. In fact, the economy is overdue for another recession that would reduce
interest rates even further. US
With that prospect in mind, we should consider Douglas French’s advice and look at bonds, especially treasuries. French warns that
“Real people don’t own the Treasury market. Central banks and pension plans do. Most of the action is in shorting government debt, whether it’s unconstrained bond funds or leveraged short Treasury ETFs.
“Gundlach warns if the 10-year rate falls below 2.47%, watch out. He says that 'you will start to see an enormous unwinding of these embedded short positions.'
“The bond guru thinks something bad will 'have happened to make that yield drop like that.' Something bad like, say, a stock market crash or contraction in the economy? Not to worry, a survey of 72 economists by the National Association for Business Economics reports all 72 think the economy will grow this year.”
Winning investors have to be contrarians, especially regarding mainstream economists.