Yes. There’s yet another cardinal rule that tells you when to get into the market and when to get out (more or less). It has never failed us and following it, helped us avoid entirely the catastrophic markets last year and turn in positive performance for 2008.  You’ve all heard it before but let’s restate it because it’s important and it works. Herewith: “Don’t Fight the Fed!”

Fifteen years ago, I codified this asset allocation dogma into our introductory literature as follows:

Our asset allocation is driven by fundamental guidelines. We substantially increase our cash allocations and sell stocks and bonds during periods of economic overheating when governmental or central bank policies are being enacted to temper economic growth through policies such as tax increases, spending cuts or tightening monetary policies manifest through higher interest rates. Conversely, we substantially increase bond and stock allocations when the opposite conditions as those above occur such as fiscal stimulation through tax cuts, deficit spending and expansionary monetary policies manifest through falling interest rates.

In 26 years of portfolio management, we’ve yet to be disappointed in following these rules. Most recently the bond market, followed by the stock market, has been rising following a freeze in bank lending and a catastrophic collapse in the money supply. The Fed is engaged in massive stimulus soon to include what is known as quantitative easing in economic jargon. The Administration is also about to embark on massive fiscal stimulus in the form of both huge tax cuts and unprecedented deficit spending on infrastructure. Bank lending, as indicated by the TED spread, is clearly thawing and resuming. But one must always be aware that there is a significant time lag before monetary and fiscal policies have an effect in the markets. The effects usually show up in the stock market first, making it the single most important component in the index of leading economic indicators.

My point here is that even in following this rule, given the lag, patience is a virtue. In the high volatility that usually occurs near tops and bottoms, it is veritably impossible to pick the very top or the very bottom and one can easily get badly burned.  I’ll readily give up that last five or ten percent at a top or the first five or ten percent near a bottom for the privilege of correctly investing in a longer term trend.

And finally, although we’ve reduced our precious metals holdings because of increasing risks of deflation, it is just that, because of increasing risks. The Feds will likely err on the side of caution in their efforts to prevent depression and deflation and we may eventually have some good ol’ rip roarin’ inflation once again, but we shall see.

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