2021 Q1 investment outlook
The basic assumption should be that the Efficient Markets Hypothesis is usually true. We should forget about frequently trading currently owned assets, and be skeptical of major asset reallocations. At any given moment, all assets are probably fairly valued, and so we should avoid second guessing our past decisions, and favor shifting the flow of new savings into our investment darling of the day, rather than ditching old investments.
That said, if we have strong opinions, we should not be wedded to this basic reluctance to shift asset allocations. Had I inherited the American retailer Sears’ shares in 2008, I would have sold, you only had to go into a Sears to see what a disaster it was. That said, corporations do have turnarounds, look at Best Buy, they willed themselves to relevance. In an alternate history, maybe Sears could have made it work somehow. The market only becomes efficient, because someone thinks it is currently sub-optimally pricing, we move toward efficiency.
To play my infinitesimal role in moving the market toward efficiency, I’ve just moved my biggest retirement fund allocation distribution into a distinctly off-risk direction. I’ve done this because I don’t think people realize how loose Fed policy currently is, and don’t reckon the Fed realize it either.
Consider FOMC incentives. They seek, like all of us to some extent, to self aggrandize and to enrich themselves. They enrich themselves by giving speeches to big wall street banks, like Janet Yellen did in the Trump years, that’s easy. Maybe Yellen leaked insider trading info while she was boss of the Fed. She certainly could have.
Back to Fed motivations. The Boomers who still dominate the FOMC came of age in the 70s when the USA had a genuine, demand-side inflation problem. It wasn’t a huge problem, but it was the biggest issue of the day, and remained probably the biggest issue in macro economics through the 80s, 90s and aughts. In the world of central banking, you gain fame and glory through achieving ever-lower inflation, even if that isn’t the best way to maximize welfare for the public. Reasonable people could agree on the relative merits of 0%, 2%, 3% trend inflation, or alternative monetary goals. The point is, FOMC members want fame and glory, and generally shouldn’t be expected to care too much about the public. Labor market tightness doesn’t affect them too much, they’re getting taken care of.
When we speak of investing (buying and holding), or of speculating (gambling in investment markets for some sweet, sweet action), we’re substantially talking about anticipating the Fed, before the median market participant anticipates the Fed. This is why speculation is so hard, and why the Fed is such an obvious target for corruption.
Why I’m moving off-risk
I’m not talking about Bitcoin. That’s sort of an independent, long term, global play that doesn’t yet have an obvious connection to the broader economy. Put that aside. If you like Bitcoin, by all means, keep buying, I am. From a macro perspective, the US economy is coming out of a very deep, short, weird recession. The regime basically outlawed much of the economy in late Q1 and into Q2 of 2020, and has gradually opened the economy back up since. The Fed really did a brilliant job and managed to foster expectations for decent nominal growth in 2021, allowing for a surprisingly good recovery, so far considering how devastating the shutdowns were.
The Fed has done such a good job, that it’s hard to imagine them keeping it up. Remember, the key to understanding the Fed is that they want low inflation.
The graph below shows the US 5-year breakeven inflation rate, a market forecast of average yearly CPI inflation for the USA, for the next 5 years. When the line goes lower, the market expects less inflation over the next five years, up, more. Today, we’re at the top end of the post-great recession range, and it’s frankly almost impossible to imagine this level being sustained.
The market says inflation will be higher in the near future, than it has been in a decade. That’s not particularly a problem per se, as inflation is very much an overrated malady, but it does have implications. Namely, that while the market thinks the Fed will have higher inflation, I do not. Today, I think I am smarter than the market, which is not a comfortable position to take, but there it is. It’s highly likely that, when inflation begins coming in hotter, that the hawks at the Fed, and influential bankers, will lose their minds. The financial press will lap it up and the main power brokers at the Fed will be under strong pressure to tap the breaks. Inevitably chairman Powell and others will start to make Hawkish statements, which will pull down NGDP expectations, and in turn pull down inflation expectations and stocks.
So I’ve moved my retirement assets out of higher risk funds, and into lower risk and bond funds. Retirement fund, whatever, it will probably be expropriated anyway. In my personal speculation brokerage account, I’m not planning to sell anything, but I will start moving new savings into some sort of bond fund, or maybe just keep it as cash. I’ll reevaluate this strategy in June. The longer the 5-year TIPS stays well above 2%, the more aggressively I will bet on it falling down to 1.8% or so. My hope is that it will fall to 1.6% or 1.7%, because then I’d feel good about accumulating risk assets again. The worst plausible outcome would be if it only falls to 2.1% or 2%. If that happens I’ll probably stop building my low risk positions, but hold on to them, and resume accumulating exciting, risky companies.