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Monthly Commentary
November 5, 2013
Fed’s Manhattan Project
Bill Henderly, CFA, Nvest Wealth Strategies, Inc.
In 1943, there was no firm answer to the question of how much uranium/plutonium was
needed to sustain fission in the first atomic bombs, or for that matter, what structural form the
“gadget” should take. Among the technical tools used to resolve these questions by then
young Richard Feynman (directed by J. Robert Oppenheimer) at Los Alamos, New Mexico, were
the growing theory of quantum mechanics and a crude Monte Carlo-like simulation.
Apparently their model prototype worked, and the rest is history. Today, a similar dilemma
confronts central bankers. Instead of uranium and plutonium, the “fissile” material is excess
reserves, and the energy released from an uncontrolled chain reaction would be the velocity of
money (how fast money moves through the banking and economic systems) and inflation.
How much of the “fissile” excess reserves are needed to form a critical mass on the Fed’s
balance sheet which could lead to uncontrolled inflation; and can this reaction be controlled.
[Note: the transmission mechanism – bank lending – is still slow via new loans (business
borrowing is slow due to low confidence in government fiscal and regulatory activities); money
velocity remains muted.] For now, QE3 is not producing any near-term inflation risks, and it is
boosting investment asset values as interest rates remain near zero. Maybe in several years, we
will begin to understand if the QE activities of the US Fed and other world central banks were
managed properly.
Delivering financial
peace of mind.
October (2013) provided another strong performance experience for stocks. In fact, the
S&P500 witnessed its sixth +100 point rally of the year (pretty extraordinary). In 2013, 8 of the
10 months already completed were positive performance experiences, with the S&P500
advancing 25% YTD. Further, it is interesting that 451 of the 500 S&P stocks are up in value
for the year. Since 1980, that’s the second strongest internal breadth on record (2003 was
stronger with 458 advancing stocks); there are only 6 prior instances where more than 400 of
the S&P500 stocks were up for the year (1985, 1991, 1995, 1997, 2003, and 2009). 2009 was
the start of the current bull market. These broad-based advances were found in the early or
middle stages of bull markets; rarely near a major top. And, the average S&P return of these 6
broad-based participation rallies was a +14.4% return, with all annual returns being positive.
All client portfolio objectives recorded attractive performances in October and for the YTD.
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October
YTD
S&P 500
+4.6%
+25.3%
Large Growth
+4.2%
+26.0%
Mid Value
+3.9%
+29.4%
Large Value
+3.9%
+25.3%
Small Value
+3.3%
+28.8%
Foreign
Mid Growth
+3.2%
+2.7%
+16.6%
+28.7%
Small Growth
+2.0%
+34.1%
Client Objectives
(Stocks/Bonds)
20/80
October
+1.0%
YTD
+5.7%
35/65
50/50
+1.5%
+2.0%
+7.3%
+11.6%
65/35
80/20
95/5
+2.5%
+3.0%
+3.3%
+14.7%
+17.5%
+19.6%
For the moment, it appears good economic news is “good news” for stocks (unlike sometimes
when good news is bad news for the markets). Today, the Fed is looking for improvement in
the economic statistics including falling unemployment in particular. The Fed is data
dependent, looking for continued “good news” improvement to allow it to gradually
implement tapering of its current $85 billion/month QE3 program to smaller amounts. When
the Fed tapers, it will be because it expects the economy to continue to strengthen and stand
on its own without QE stimulus; separately, the Fed will keep interest rates low well-beyond the
conclusion of QE3. < continued on page 2 >
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Fed’s Manhattan Project -CONTINUEDThe US economic backdrop is not bad, but is not accelerating as the Fed was hoping in September; thus, the key
reason for the delay in beginning taper-QE3. Leading up to the government shutdown, a surge in mortgage rates
from late May hit housing pretty hard and rippled through the economy. Employment gains slowed. Then the
government shutdown – running the first two weeks of October – lowered consumer and business confidence
alike. Since the shutdown ended, there is slight economic improvement. Taper-QE3 is still delayed, probably to
January or March. Yet, for all the negative news, the stock market advance of 2013 will likely be attributed to QE3
– it propelled the stock market.
Stocks, even after the latest run in October, remain unusually inexpensive when compared to bonds. Yet, for
further future stock advances to occur (as QE3 concludes), investors will be like the Fed – data dependent.
Investors will need to transition from a QE3 rising stock market to one that rises because of increasing revenues
and earnings, hallmarks of economic growth. This suggests to us that a diversified investment portfolio should
include actively managed funds. Use of actively managed funds will reward investors who can pick winning
growth companies. There are 40 trading days remaining in 2013, and the backdrop remains supportive for
additional upward walk.
Next year, we wonder if 2014 will be the year of a synchronized global recovery. Growth is not great anywhere;
but it is positive most everywhere. After several years of decline and struggle, Europe is starting to recover; Japan
is experiencing economic progress from Abenomics which is 4 times the magnitude of QE activity pursued in the
US since the beginning of 2013; and China, who was facing a hard landing, is now showing good transitional
growth from an export-focused economy to one driven increasingly by its own population as consumers. This is
the first time in many years where the experience of a synchronized global recovery should be like having the wind
at your back instead of a headwind in your face. It should aid business revenue and earnings growth, which
should further the upward advance of stock prices. Foreign investments show greater undervaluation than US
domestic stocks. A synchronized global recovery reduces the odds of a US recession. The only concern to monitor
is if this “good news” remains viewed as good by investors. Good news could be deemed bad if economic growth
becomes too swift causing investors to fear inflation and push interest rates too high, resulting in a short-circuit of
the recovery. The Fed would be well-advised to strip the taper of its signaling value by using forward guidance to
sketch out a base-case balance sheet path, for which the Fed unwinds QE well ahead of changing policy interest
rates. Forward guidance is the Fed’s Manhattan Project – designed to engineer the economy to a stable ground
with managed/low inflation.
In the meantime, investors should stay invested, and keep watch.
Nvest Wealth Strategies, Inc. |
Delivering financial peace of mind.
www.nvestwealth.com
Ph: 740.917.9234
2310 Home Road
Fax: 740.917.9234
Delaware, Ohio 43015
Email: [email protected]
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