Economists, Politicians, & Financial Media: Tune out the Noise
My goal was to write an objective overview of the current discussion on interest rates. I have already failed and I’m only on the second sentence. I just can’t bring myself to waste the time to actually do it. I remember back in college when I took an ethics class and we had to choose a topic and debate both sides of the issue. Part of our grade was whether we could objectively present both sides without our own bias being detected. I couldn’t do that either. I’ve learned a lot since college and I know that failure happens often. I’ve also learned that failure is the stimuli that leads to learning and change. We’ll come back to that point at the end.
In December 2008, the Federal Reserve (“Fed”) lowered short-term interest rates in the United States to 0.0%. Interest rates in places like Japan had seen a level of zero before, but not in the good ole’ USA. At the time the US financial markets were in complete meltdown over the financial crisis that gripped the US housing market, financial institutions, and economy at large. The Fed sought to force interest rates lower in order to make the cost of capital as low as possible. The narrative was that lower rates would alleviate pressure on debtors, free up monthly cash flow that could be spent on other things thereby causing the economy to return to its former self and the Fed would undo all the tricks it had to pull to make all of that happen in relatively short order.
Here we sit almost 8 years later. Interest rates have been lifted once to the dizzying height of 0.25% in those 8 years, after countless promises and threats to raise them every few months failed to materialize. A lot has transpired from the depths of crisis to where we sit today. What can we learn from the past 8 years? With the beauty of hindsight, there are a few key things that we can take away from this historic period:
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Economists and political figures are wrong a lot when they try to predict the future. Really wrong. A lot. Below you will find some examples from the past few years when most prognosticators have struggled in the prediction business.
“While economists think there’s a chance the Fed could raise rates next year, few would be surprised to see them stay on hold all the way through 2010. A survey of 48 top economists by the National Association of Business Economists foresees rates at current levels through the first quarter of 2011.” CNNMoney.com December 15, 2009(Note – those “top economists” were only off by roughly 5 years.)
Richmond Federal Reserve President Jeffrey Lacker said on Friday he believes the U.S. central bank will have to raise interest rates in mid-2013, not late 2014 as suggested in this week’s policy decision. Business News, Friday April 27, 2012(Note - Getting better, Mr. Lacker who was a Fed President at the time, was only off by 2.5 years.)
In an interview on CNBC, {St. Louis Federal Reserve Bank President James} Bullard was asked to share his expectation for when the first increase of the federal funds rate would be. His response, “In 2013.” CNBC, Friday February 24, 2012(Note – Mr. Bullard, who has famously been all over the map along the way, was also quite a ways off from reality.)
“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.” Ben Bernanke to the Joint Economics Committee of Congress on March 28, 2007 (Note – In hindsight, this is perhaps one of the most cringe-worthy statements by a policy official in modern times.)
In summary, the economy is a complex system which makes it incredibly difficult to predict in advance. The Fed has been sensationally abysmal in its economic forecasts of future growth and its plan to normalize interest rates. The reality is they (nor anyone) can accurately predict the short-term future with any consistency. That fact apparently will not stop them from trying.
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The news media and most financial pundits get things wrong too. They generally increase noise to market participants instead of distilling information.
I have no idea how much time has been wasted spent analyzing the changes in Fed statements over the past several years. Neither do I know how much time has been wasted spent by Americans consuming internet, TV, print, and radio content devoted to monthly job numbers, Fed meetings, and government economic forecasts. The financial news media hangs on every word from the Fed. Algorithms are coded by investment traders to read the minutes of Fed meetings and react by buying or selling securities at lightning fast speeds. Given the conclusion in point #1, I think the silliness of this will become more and more clear over time. Investing is a long-term endeavor, and focusing on what some non-elected (or elected) bureaucrat said in a meeting a month ago is just noise. Focusing on how many jobs were created across the United States in July is also a waste of time.
Source: The New Yorker
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Over the long-term, interest rates are going to rise. When they do, financial markets will probably not enjoy the process. This will happen at some point within the next 6 months to 50 years.
Okay, the 50 years comment was to avoid me being in the collection of people I defined in point #2. No one knows the future, but given bond rates have fallen from the early 1980’s to present in a fairly simple, downward sloping 45-degree line, it doesn’t seem like much of a reach to say that trend is a little long in the tooth. What will rates do over the coming couple of years? I really do not know, and people much smarter than I wildly disagree on the topic. Over the next 10-20 years, rates are going higher. Prepare accordingly.
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US corporations are brilliant and ruthless in their endeavor to promote profitability and sustainability. That statement might sound negative, but that completely depends on your perspective. As an employee, supplier, or competitor, this attitude can be harsh and unnerving. As an investor in a company with this attitude, it is refreshing.
Look at how efficiently US companies (not necessarily workers) healed coming out of the financial crisis. Millions of jobs were cut, wages pulled back, investment stymied, and disaster plans invoked. In time, it worked like a charm for companies that made those difficult decisions. Great companies make hard decisions and then move forward. This simple fact should be one of the bedrocks of a successful investment strategy.
In closing, let’s go back to failure. Life has a hard way of using it to help us learn lessons that we wouldn’t choose under any other circumstance. Economists, policy makers, members of the financial media get things wrong. I suppose that making predictions and trying to fill 24-hour news channels with content and driving eyeballs to websites make that a reality. The takeaway is that many of those predictions are going to be wrong. Therefore, making investment decisions on erroneous information can only lead to failing investment decisions. By pulling our focus from Federal Reserve blathering, short-term economic data, and media prognostications and thinking as potential owners of real businesses, the greater the likelihood of future and repeatable success as investors.