The U.S. Fed: twisting and turning

Dollars and Sense

Whatever it is, the U.S. Federal Reserve is trying it. It is not new.  It has been tried before — in 1961 to be precise — and guess what, it was largely considered to be a failure then.

The idea of “Operation Twist” is to try to bring down longer term interest rates in an effort to stimulate the economy. Without getting into excessive detail, it works like this: the US Federal Reserve sells short-term treasuries and uses the proceeds to purchase longer term treasuries. Presumably this would serve to bid up longer term treasuries thus pushing down their associated interest rates.

Immediately after Operation Twist was announced, the stock market fell with the Dow Jones Industrial Average closing the day down 283 points. Already the financial pundits were referring to Operation Twist (#2, I guess) as a failure.

Why would they reach such a conclusion after only a few hours — most likely before even a single longer term treasury associated with the strategy had even been purchased? It’s obvious — because the stock market went down.

Since when was the goal of fed policy to prop up the stock market? Actually, for quite a while now, though that’s a whole different story.

In my opinion it is just plain bizarre, on a number of fronts: that the Federal Reserve would use a strategy that hasn’t been used in 50 years, and was a failure when it was used; that they would use a strategy that could potentially cause further damage to an already fragile banking system by flattening the yield curve; and that we have gotten to a point where Wall Street assesses the success of economic policies on the basis of the one-day performance of the stock market.

I don’t get it, and I’m sure a lot of you don’t either.

But here is what I do understand. The economy is weak, and will likely remain weak for some time. And here is my advice: even if by nature you are an optimist, you would be well-advised to temper that optimism with a healthy dose of realism — at least as far as your investments are concerned. You should remain diversified. Make sure you have a healthy exposure to fixed income, own some gold, and be selective in terms of the stocks that you do own (if you choose to own stocks). Some exposure to hedge funds (assuming you are an accredited investor) may also be worth considering.

If on the other hand, you are a pessimist by nature, here is some more advice. Don’t be too pessimistic. The world is not about to end. There are still lots of successful companies out there (i.e. Apple Computers) that are and will continue making money and are still very good investments.

For more on how to invest in such a crazy world, join us on September 28th at the Parksville Community and Conference Centre and learn what is working for us.

Please call 250-594-1100 to register for this event.





The views expressed in this article are those of the author, and are not necessarily those of Raymond James Ltd.