Capital markets spent the first half of the week calmly waiting for two things; a German court ruling on the constitutional ability to fund the ESM bailout fund, and the Fed meeting announcement. In both cases, equity investors got what they wanted. Germany was cleared to be the largest provider for the ESM and Bernanke yet again exceeded expectations for additional stimulus. The Fed committed to buying $40 billion of mortgage backed securities per month for an indefinite period of time. Stocks rallied. The unprecedented actions by the Fed also fueled inflation concerns, causing Treasuries to fall and gold to spike.
S&P 500: 1,466 (+1.9%)
MSCI EAFE: (+3.6%)
US 10 Year Treasury Yield: 1.86% (+0.19%)
Gold: $1,771 (+2.1%)
USD/EUR: $1.312 (+2.4%)
- Monday – Greek Prime Minister Antonis Samaras met officials from the nation’s creditors after failing to secure agreement from coalition partners on spending cuts.
- Tuesday – Moody’s announced it may downgrade the U.S.’s credit rating unless the deficit can be reduced next year.
- Tuesday – A former UBS banker who helped the US crackdown on tax evasion (after confessing to helping to defraud the US) was awarded over $100 million by the US government. It was the largest whistleblower payout ever.
- Wednesday – The US Ambassador to Libya and three other Americans were killed in a brazen attack on the US Embassy, purportedly in reaction to a film posted on YouTube depicting the Prophet Mohammed in a negative light.
- Wednesday – Apple unveiled the iPhone 5, a slimmer model than its predecessors, with a longer screen and faster connectivity.
- Thursday – Germany’s top constitutional court rejected efforts to block a permanent 500 billion-euro rescue fund.
- Thursday – Unrest spread in the Middle East related to the YouTube video as protesters attempted to storm the U.S. Embassy in Yemen. At least four were killed. Demonstrators also rallied in Egypt and Iran.
- Thursday – The Federal Reserve announced an aggressive program to spur the economy through open-ended commitments to buy $40 billion of mortgage-backed securities per month, and by signaling intention to keep interest rates low for years.
The Fed has a duel mandate: maintain full employment and price stability. Right now, unemployment is stubbornly high and inflation is persistently low. So it’s no mystery why Bernanke and the Fed are being aggressive.
In theory, if you print more money, inflation should increase proportionally. Including the newly announced program, the Fed will soon have pumped more than $3 trillion into the economy. That is a lot of money. But Japan followed similar policies for decades and inflation never became a problem. Predicting inflation is extremely difficult, so we try to avoid it. Frequently, capital markets are more adept at signaling the economy’s direction than people are. The fact that Treasuries plummeted and gold spiked following the Fed announcement indicates capital markets do expect inflation.
Inflation can torpedo your retirement plans just as effectively as a nasty bear market. Portfolios overweight to cash and bonds are most vulnerable. Whatever your view on inflation, having some assets to protect against its perils is wise.
A quick note on stocks: The S&P 500 is now up about 18% year to date. This remains under-appreciated, but is garnering more attention. Eventually, the greed side of the market should kick in and the bears will capitulate. For fund managers, it is becoming almost mandatory. A bearish manager who has lagged modestly this year can write it off as a bad year, but missing another up-leg from here could be a career killer. There is a mountain of cash on the sidelines. It won’t all be rosy, however. The problems in Greece and Spain will resurface again.
A quick note on the Presidential election: Romney will make all the noise he can about high unemployment, but 92% of the voting workforce still has a job. With a climbing stock market and rising home prices, Romney faces a tough battle. Whatever you think about Obama, the S&P 500 is up over 80% since he took office. That won’t match Clinton, but it usually won’t get you thrown out of office either.