“We never expected to find ourselves in an environment like this again, given the savings that were lost when the internet bubble popped.” David Einhorn Q3 2013 quarterly review.
David Einhorn has arguably the best hedge fund track record over the two decades and this time the situation may be even more volatile than the 2000 bubble as there is a new factor to consider. The Federal Reserve has never before been such an all pervasive presence in both the markets and the economy. As Jim Grant, the well known Federal Reserve historian, put it:
“At the heart of the Fed’s regime is the subordination of freely discovered prices to policy goals.”
What is an investor to do when instead of trading freely discovered prices you are trading Federal Reserve adjusted prices, even as the Federal Reserve’s policy failures are mounting. Dr. Lacy Hunt does a great job articulating this in clear and simple terms:
These are not idle issues as current economic and market settings can only be regarded as extreme in every way. This is where we need to get to the chart John Hussman sent out today which says it all.
Only 3 other times in the last 43 years have we had a sell signal for equities on the criteria he chose. In each of those cases it was a major high in the stock market – 1972,1987, and 2007. This November is the third time we have achieved this signal, to go with May and August, in just the current year!
The Federal Reserve is now having an increasingly erratic impact on the markets even while, as discussed above by Lacy Hunt, its impact on the economy is in decline. After all if the banks already have over $2 Trillion in excess deposits already, what difference will even an additional $1 Trillion really have?
Furthermore, the latest data suggests that retail sales and the labor market are already in weakening uptrends, to go with the persistent economic downgrades from the IMF and the Fed itself and the very weak data from Europe this week.
Stock market risk is clearly rising. This is why I am increasingly gravitating to the All Weather Allocation, which has an equal weight of 25% in cash, bonds, stocks, and gold. The data on how this benchmark has performed over the last 43 years shows the remarkable resilience of this model, no matter what kind of cycle it has to go through. Here is the data at the end of this article:
No doubt there will be substantial opportunities given the extreme circumstances, but this will also be a highly volatile period. How will you manage your expectations and financial planning if any one of these sectors could soar or crash as we move through the current predicament? Why not now regard your economic baseline as the most stable financial benchmark over the last 43 years?
Most likely you will be closer to the mark and better able to make good decisions in very uncertain times.