Fed Theater
As there were no further attacks in Afghanistan, the market’s attention on Friday turned to the Federal Reserve meeting in Jackson Hole. Many people are confused as to why the Fed matters so much to the market. There are two reasons. First the Fed controls, in large part, the degree of monetary liquidity in the market. i.e. how much money is available to lend, invest, trade, etc. Second, it’s dictates interest rates in the market as the ‘Feds Fund Rate” (the interest rate depository institutions like banks charge each other for overnight loans of funds) is the benchmark most financial institutions use in setting their own interest rates. A decrease in liquidity or an increase in interest rates will have a chilling effect on the market. Higher interest means it cost more to borrow (think mortgages and other big ticket items like farm equipment) and as a result people have less to spend and it slows a consumer economy like ours. Higher interest rates also tend to hit the stock prices of tech companies harder as analysts, who frequently use a valuation method called discounted cash flow to value tech companies, have to use the higher interest rate in their formulas. This interest rates sits in the denominator of the formula, so the bigger the number the lower the valuation the calculation spits out. Tech companies end up looking less valuable and their stock prices fall.
But lower liquidity and higher interest rates are not all bad. Less liquidity generally means less stupid money funding companies selling little more than promises. Higher interest rates help older people depending on interest for income in retirement. In my lifetime, I remember my first mortgage was at 8%, and I thought I had gotten a great rate. We expected returns on our investments would be an easy 8-10% (interest on savings accounts and bonds), which encouraged us to save. It was easy to imagine accumulating enough savings to live comfortably in retirement. Now, with savings accounts generally paying less than 2%, no one can expect to retire unless you have saved millions. Social security is not intended to cover all your expenses in retirement so investing in the stock market, which is riskier, has become essential for retirees. The choice for older people, is to delay retirement indefinitely while scrambling to find relatively safer market investments. A rise in interest rates could mean a major shift in the anxiety older Americans feel about retirement.
The Fed clearly understands it role in balancing these competing forces. Unfortunately, it has not always been great at telegraphing its position. In 2013 the Fed suddenly announced a major policy change. It was not well communicated. It announced it was going to reduce the quantitative easing that it had put in place to deal with the 2008 financial crisis. Pundits made it sound like the world might end and the stock market quickly dropped 5.6%. This drop is what people call the taper tantrum, but mind you a drop of 5.6% does not even qualify as a correction (10%). And you rarely hear that the stock market then rose 18% for the remainder of the year.
This current Fed is offering a master class in communication. The day before the Jerome Powell’s speech (he is the Fed chair), other members of the committee came out on camera to say they are ready to start easing, now. The market started sobering up and began to sag. Next day, Powell made his speech saying that they would not be starting easing immediately but were now looking at it. Market rallied as it appears tapering was not imminent. This constant Fed speak is prepping the market admirably. Given all the back and forth talk and all the opposing opinions taking up on-air discussion, by the time easing actually starts, it will probably be a sigh of relief that we have quit talking about it and are actually doing it. I don’t see how a taper tantrum is likely as the market seems to have been told it is coming in a thousand ways. Most people view tapering (decreasing the amount of money released into the market and eventually increasing interest rates) as a statement on the improving health of the American economy. An economy with higher interest rates is a strong economy. So for me, bring on the tapering, and give me a some safe investments with solid 6% returns!
Market Today: The market recovered from Thursday’s nervousness over Afghanistan and the Fed tapering talk (three Fed speakers all sounded like it was imminent). The rally meant I could close a lot of puts. Given MRNA was down, I wrote two sets of puts, closing one before the day ended, hoping the other will close on Monday. Normally Friday afternoons the market lags and I can use the last 30 minutes to write a puts for Monday. Today it was up into the close, so I only wrote a few small ones, and wrote calls for my retirement account holdings. (I only write calls in our IRAs, I save put writing for my investment account). There have been 10 inter-day highs in the stock market so far in August. This is almost unheard of. August, September and October are historically volatile months, and over the years there have been a lot of corrections (10% drop), and some crashes (20% drop) in these months. I am being cautious and have about 20% of my investment account in cash so I can buy if the bottom falls out. I have a shopping list ready.