Dark Side of the (Fed) Moon
By Julien B. Booth
April 27, 2018
I hope this note finds you doing well and enjoying the emergent Spring.
Beginning in mid-February the return of reality has been inflicting pain on investors – both their portfolios and their expectations.
For several years we wrote continuously on the distorted affects of Quantitative Easing on asset prices. In short, effectively diluting ones (U.S.) currency by the Federal Reserve made ALL asset prices increase by lowering interest rates towards the zero bound. Nothing like a money market yield of 0.01%. European/Japanese central bankers even have the brilliance of negative rates!
Vintage FC investor note reference: https://www.brcwm.com/2016/03/11/cocaine-heroin-and-now-ritalin/
We are embarking on the other side of the Fed’s moon – Quantitative Tightening = Increasing Interest Rates = Decreasing Asset Prices
As you might expect, very few investors enjoy the returning of this economic reality. There is no free lunch, nor monetary law that can be forever disobeyed (Japan has certainly tried).
Given our preference for Preservation of Capital, the strategy utilized during this period is far different than riding the intentional inflation of asset prices (its over now) by the Federal Reserve.
Per our last 2 notes, we now prefer assets that float upward = reset to rising interest rates. Senior Loans, Fixed-Float hybrid securities and improving/workout credit stories remain our favorite asset types. TBTF (Too Big to Fail) bank hybrid securities are especially attractive; they float on interest rates + underlying credit improvement vis a vis rising rates.
Given our tendency to be a touch early…we are now positioned well for the good side of economic growth, but for stocks rising interest rates = Quantitative Tightening. Beware.
Hysteria will abound regarding the rising yields of the 10 Year U.S. Treasury over the coming weeks; it is all part of the process. Rising rates signal a return to normalcy (whatever that is) and are a healthy sign that the U.S. remains the most dynamic global investment destination. Investors however…may prefer the Fed not leave, or at least not leave them.
As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.