Welcome to the first Perspective in our new quarterly series. The format is the same: our comments with a link to a third party perspective on topics we hope you find interesting and beneficial to you, your family and your network.
This quarter our comments run a bit longer than normal and are followed by a link to a recent note from Dr. Ben Hunt, a true expert on game theory, human behavior and narratives.
If you’ve ever been hooked on a Netflix TV series, you know that feeling when you get to the last episode… right? You’ve invested hours upon hours learning and eventually anticipating a particular narrative. Then, with the final credits in the series finale episode, your “investment” simply evaporates. Feelings of emptiness and loss of direction ensue. The solution? Fill the void with a new series, a new narrative, and hope it’s as good as the last one!
It might sound silly, but this phenomena is becoming a common cultural experience as TV consumption continues moving to on demand streaming formats. Amazon Fire actually has commercials playing on the mental and emotional anguish people experience at the end of a series, or, narrative. They call it “showhole.” If you search “showhole” on You Tube you’ll see the commercials.
The purpose of this is to highlight our attachment to narrative, or more specifically, to look at our behavior when a favorable narrative ends. This is a timely exercise for investors because a very favorable investment narrative that has been in place for the better part of a decade is ending.
Since 2009 the Federal Reserve’s policy narrative to investors has been, “go long, the Federal Reserve has got your back.” This policy was most clearly communicated by the Fed targeting “asset price inflation” (higher stock prices) to create a “wealth effect” (the idea that you’ll stimulate the economy by spending more money today if your accounts are going up in value). If would like to see how narrative played out in data, I created a fun little chart using the Federal Reserve Economic Database just for you: https://fred.stlouisfed.org/graph/?g=e7vM
The blue line is the Federal Reserve’s balance sheet. When it goes up, that’s the Fed printing money. Since 2009 when the Fed prints money the stock market (red line) goes up. When they stop printing, the market doesn’t go up. The response has been to print more, rinse and repeat.
The final credits on the Fed’s “we’ve got your back” narrative began to roll when the Fed announced it will begin to shrink its balance sheet later this year. That means the blue line in the chart will start to go down. Like TV viewers enter a “showhole”, here investors enter a “policyhole.” This is the no-man’s-land between policy narratives. Inside the policyhole, questions abound: Will the stock market follow the Fed down just as it followed on the way up? Is the Fed committed or will they reverse policy at the next market sell-off? Will the market continue to go up and some other narrative evolve that breaks the extremely high correlation between the stock market and Fed money printing?
To wrap this up using our TV series analogy, we’ve just watched a pilot narrative air post-election as the market rallied on a lower tax / pro-business narrative. Whether this pilot gets traction and turns into a series with real data can only be seen in hindsight.
As advisors, our narrative remains the same: The future has always been uncertain and it remains so today. Diversify your investment risk across asset classes and management strategies. Structure your portfolio with appropriate risk buckets and allocate to maximize your return for the level of risk you are comfortable accepting. Remember, the purpose of your portfolio is “to get you all the way home” in terms of your goals and objectives and to do so in a manner that is comfortable to you.
If you are interested in learning more about narratives and Fed behavior, check out Dr. Ben Hunt’s post-Fed Follow Up note here: http://epsilontheory.com/wp-content/uploads/epsilon-theory-ben-hunt-post-fed-follow-up-june-16-2017.pdf
Have a great summer and remember, GOAL stands for Get Outside And Live!