Barry Ritholz has had a long career, both participating in the Wall Street machine operates and opining on how it operates. By any account, few understand the ‘street rules’ of modern investing better than he.
And he thinks many investors today, both individual and professional, are letting themselves get dangerously distracted.
In a May article titled Where Sea Monsters Live, he observed that many fund managers spend more time railing at Fed policy than on their own portfolio strategies. Yes, the seas have become more turbulent, admits Ritholtz, but that’s exactly when the captain’s expertise is needed most. Simply cursing at the winds and tides will not get the ship to safety.
By the way, I do not want people to misunderstand this. It's not that people shouldn't be criticizing the Fed; it's not that people shouldn't be actively and vocally debating public policy and monetary policy. But if you are doing that instead of managing your assets, if you are doing that instead of paying attention to how you should be positioning your portfolio, you are going to be in trouble as an asset manager.
The priority, he says, is to accept that – for good or for bad – central bank intervention is an integral component of financial markets now. Whether you approve or not is immaterial; if you are a steward of capital, you’d better work quickly to develop an investing approach that takes the range of likely Fed actions into account.
Markets are driven by human nature; they are driven by psychology of fear and greed. Sometimes the fear is missing out on the rally. Sometimes the fear is uh oh, things are going lower.
What changed the game so dramatically post-2008 crisis is the footprint of the Federal Reserve and what they are doing. And so, if the Fed was not involved in this market I would be looking at decelerating macro economics, I would look at earnings peaking and reversing, I would look at a number of factors that would have me radically reduce my equity exposure.
We run an asset allocation model that uses a 60/40 benchmark. 60% equities; 40% fixed income. We came in to the year 80/20, way overweight in equities, and as the market has rallied – each time we rebalanced to take a little bit off the table. But we have also made a conscious decision to go to equal weight as opposed to overweight. Now, if this was a normal situation I would probably be 40/60. I would probably be 40% equities, but it is really, really challenging to say. Despite the fire hose of liquidity, despite the really low fixed income rates, I want to still sell stocks. In light of what is going on, I just cannot do it.
By making bond yields so low, you drive money out of bonds into equities, and by providing so much liquidity to banks, history has shown us that when that happens it seems to find its way into equity markets. When you look at that historically, when you look at when the Fed says we are going to increase liquidity, we are going to put a lot of cash into the system as a lubricant, the impact is that risk assets go higher. And that is pretty much stocks, bonds, and commodities – and the dollar weakens. Look at what happened under Greenspan and once Bernanke took over. From 2001 to 2007, the dollar lost 41% of its value, and I have no doubt that was driven by Fed policy.
If this was a normal situation, I would be battening down the hatches and waiting for this storm to come forward. Instead we are looking at a Fed with a fire hose and wondering every time there is a 10% to 20% correction in the equity market, they throw more cash at the system in order to generate some improvement. And I keep coming back to this from our original conversation about Where Sea Monsters Live. It's more than just being the armchair critic. The impact of this from an investment perspective is: “I want to own this and I do not want to own that for all of the above reasons.” Where people seem to falter is in taking it to the next step and saying, “Well, what does this mean from a risk versus reward perspective?”
Click the play button below to listen to Chris' full interview with Barry Ritholtz (48m:51s), including his his thoughts on gold:
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