August 12, 2003
The Greenspan Games That Investor’s Shouldn’t Play
At this time last year the 10-year Treasury yield was at 4.22% - or roughly the same level it is at today.  This is interesting, especially when you consider that leading into September 2002 many economists feared a double dip recession, and today no one dares mention anything but an economic rebound…

Bill Gross has repeatedly warned clients that the ‘salad days’ for bonds are over, Warren Buffett has cautioned that stocks may only average low single digit returns over the next decade, and Leonhardt and Markels, from the NY Times, argue that “This may well be the most confusing time for investors in more than 20 years”.  The average investor, confused by these and other dismal outlooks and left speechless by the recent volatility in the bond market, ponders: ‘what should I do?”

To begin with, what the investor should not do is pay much attention to today’s FOMC Statement.  To be sure, unless Greenspan is out of touch with the financial world his goal when crafting today’s statement is clear: soothe bond investor’s rising yield fears or risk derailing the global economy.  In short, and after the initial, potentially violent reaction in the marketplace, today’s FOMC statement should slip into obscurity. This is not to suggest that the possibility of a bond market meltdown has kicked-over. Rather, that the bond market should soon go back to monitoring the economic reports and stop hanging on the Fed’s every word. 

As for specific investments – at least those of the asset allocation variety – there is not one area that jumps out as being undervalued. Rather, we are in, as L&M suggest, a rare, and confusing investment climate; one wherein the ambiance is that of a future riddled with paradoxes. For example, U.S. government deficits are supposedly the cure all for economic growth, yet government deficits threaten to push long-term interest rates higher and/or pummel the dollar. Then there is the productivity conundrum – which facilitates a fantastic ‘new economy’ one day and is nothing but a jobs killer the next. Last but not least, there is the employee outsourcing contradiction – hello India and China – which is good for corporate profits but bad for the U.S. economy as it increases unemployment (which is bad for profits?). 

Suffice it to say, if you can make sense of all these simple paradoxes – leaving the more complicated ones to mad scientists - then Nostradamus is your new nickname.  If, on the other hand, you are scratching your head, concluding that no asset class is attractive given how unpredictable the future is, then welcome to the club.

Potential Problems Even For The Sidelined

Even if you surmise that no asset class is extra attractive and want to sit patiently in cash, an engrossing question arises: ‘what form of cash’?   Quite frankly, with the almighty U.S. dollar seemingly destined for another set back, following the likes of Soros into other forms of fiat could be wise. Then again, unlike Gross and Buffett, what Soros says one moment can change the next (or when his quick profit is made). Thus, stocking up on Loonies and Euros – tantamount to parking in more attractive government yields - could prove fruitless. 

Incidentally, with regards to the dollar keep in mind that a gradual slide in the dollar could – like a cash translation drip – be the I.V. that many American companies require to keep year-over-year EPS comparisons pumping. And since financial market participants rarely catch on to a drift but usually need to be smacked in the face, it may be just a matter of time before Snow and company start suggesting a weaker dollar (and stop pestering China to revalue?)  This is food for thought for the sidelined, especially since the overvalued U.S. dollar debate has slipped into the background as of late.

Embrace Ignorance

I have given up trying to figure out which asset classes may benefit from the paradoxes in the marketplace, and begun fearing the worst.  Why ‘the worst’? Because with bond yields possibly not even near done spiking, stocks pricing in greatness, and currency prices easily miscalculated for extended periods, I can’t bring myself to purchase anything new today except an old favorite: precious metals.

Even so, gold – as it continues the fight to regain its safe haven status – is not invulnerable. Perhaps the U.S. recovery takes hold, the dollar’s demise is spared for a few moments longer, and central banks opt to dump more reserves next year?

The Worst May Yet Come

Nearly every pre-Volcker economic recovery has eventually been threatened by rising interest rates, yet for some strange reason today’s jump in interest rates has immediately prompted a barrage of doomsday scenarios. Why? Because everyone seems to realize – whether they admit it or are paid not to - that the stock market should not be trading at near record high valuation levels at the beginning of a recovery, that gold should not be strutting its safe haven status this early in the recovery game, and that rising interest rates should not already be threatening to cause an financial blow-up that the low-on-ammo Fed can not even repair. 

Look at it this way: does anyone actually believe that the overcapacitized U.S. economy is close to overheating? No!  Rather, the threat today’s bubble watchers are worried about is not an unwelcome pick-up in inflation, but a full blown financial meltdown should any liquefied financial market begin to debubble. 

Accordingly, the more pertinent question than ‘is the economy close to overheating?’ is ‘does anyone actually believe Greenspan knows what he is doing?’ After all, if it were not for Greenspan – Mr. Productivity Miracle, Mr. Irrational Exuberance, Mr. Printing Press, and Mr. Deflation – many of the paradoxes confusing investor’s today would not be so poignant.

Suffice it to say, if you can figure out Greenspan – meaning the incomprehensible investor reactions to anything related to Alan – only then you can make sense of things. If not, sit back and begin to chant: ‘the worst may yet come’…

Conclusion

Although Buffett’s Berkshire has been known to dabble in S&P put option strategies from time to time, Warren Buffett is typically a long-term investor.  Thus, when Buffett dumped $9 billion in long-term government bonds before quarters end – right as yields began to spike higher - he probably did so simply because he no longer believed that these investments were attractive. Perhaps Buffett was lamenting over Greenspan’s next move…perhaps, but not likely. 

Bill Gross and Warren Buffett – two long-term thinkers that are often taken out of context by short term enthusiasts – don’t know what is going to happen in the near term.  However, given that today is undoubtedly one of the most confusing times for investors in the last 20-years, the long-term investment outlooks from Gross and Buffett are worth remembering on a daily basis. If you are looking for Greenspan or anyone else to yell ‘all aboard’ before the next momentum train leaves the station, you could be setting yourself up for a collision.  If, on the other hand, you are prepared to patiently peck at investments in any asset class when no one else wants to – i.e. be greedy when others are fearful – your decisions may be slower moving but safe.

Vague metaphors and indecisive rhetoric aside, Greenspan would have already been tried and convicted if he was a CEO of a major corporation for repeatedly lying to shareholders. Instead, and since he is an untouchable central banker, anything and everything Greenspan says is revered by faithful investors as a form of financial gospel. The freakish Alan sparked bond rally was worth selling because it overestimated the risk of deflation, but bonds may be soon be worth owning (once rising interest rates are about to take the U.S. economy down a notch).  When exactly is the U.S. economy going to be taken down a notch? Normally I’d have an answer, but Greenspan’s games have helped turn me into a sidelined gold digger during these strange summer months.

BWillett@fallstreet.com

 

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