“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

– Warren Buffett

For several weeks, we have intended to write about some of the structural issues that we believe are both important to long term investing, and also being pretty much ignored by policymakers. The problem with fundamental analysis is that by its very nature, the output from such analysis can only be used by long term investors. Yet, at the same time we need to understand that successful long term investors need to know when to bet against the crowd.

For a number of years now, central bankers have fought tooth and nail to prevent anything that even hinted of financial crisis. As their policies have become more extreme, so markets have become more dislocated from the underlying economic reality. Investors everywhere have become much more short term in their thinking and increasingly worried about underperforming if they bet against the crowd. We will get around to covering the serious fundamental analysis that we prefer writing about, but today we will slip into the crowd and consider the short term ramifications of the Fed and Bank of Japan meetings this week.

First up, it is widely expected that the Fed will make no change to policy. We do concur with this widely held view, and any excitement will be because of what chair Yellen says in her press conference. Unfortunately, Yellen’s public appearances tend to either create confusion or, if markets are selling off, simply encourage reflexive buying of risk as she coos dovishly. With markets still relatively well behaved, she is likely to tell us how well the domestic economy is doing, how they need to be vigilant to risks (especially those overseas ones), how they think the next move will be to raise rates but that rates will remain low in the long term.

To be utterly frank here, knowing how the market will react to Yellen’s utterances is not entirely clear to us. Even if we knew exactly what she was going to say, we are not sure whether we could use that information to make money. Perhaps when markets become so misaligned with fundamentals, and central banks are pursuing such extreme policies, price action becomes so erratic that trying to trade around central bank meetings is becoming counter-productive.

Several hours before the Fed, we will have the outcome of the Bank of Japan meeting. What is so interesting is that Governor Kuroda has promised to announce the results of a comprehensive review of their policies. Despite not meeting their goals, the review will not admit any failings and current policies will remain in place at a minimum. Indeed, the debate appears to have moved onto how they can increase stimulus further, and it would appear that the great new idea is to steepen the yield curve. To do this, they may cut the overnight rate further into negative territory and concentrate the JGB purchases in shorter maturity bonds.

Although a steeper yield curve is a positive environment in theory, we really are talking about fiddling whilst Tokyo burns here. To achieve a steep enough yield curve to make a difference, they either cut the overnight rate deeply into negative territory, which may prove to be counter-productive. Or longer dated bond yields rise a lot (price falls), which may well impact global bond prices sufficiently to cause a more widespread sell off, as we described last week.

Although the smoke signals from the Bank of Japan appear to be leaning this way, it also appears that not all members are on board. The committee appears divided. As with the Fed, the Bank of Japan has seen erratic market action post recent meetings regardless of whether they have eased policy or not. Again, we are not sure we could make money trading Japanese markets even if we knew today exactly what the BoJ would do and/or say.

So for the next few days, we feel like we are being held hostage by Central Bankers who look more and more like the Wizard of Oz just before his cover is blown. Our tendency remains risk off in our portfolios as we believe that’s where the fundamentals suggest we should be positioned, however, our conviction is lower than usual. We look forward to reverting to some serious fundamental analysis in the weeks ahead and hope that it offers some value in an increasingly distorted financial environment.

 

Stewart Richardson
Chief Investment Officer