The NorthFork View

Spring is a time of transition. Since it is a rite more than a routine, it is a time of reflection as well.

I’ve previously mentioned Novruz Bayram and one of the rituals of the Persian New Year that occurs around the time of the Spring Equinox. Participants leap over a fire, casting the previous year’s troubles into the flames to greet the new year unburdened. No less this year, a fresh perspective helps us remember that the past yields many lessons, but should not necessarily be considered a blueprint for the constructing our future.

What ended as a banner year in the U.S. stock markets last year started less confidently in 2014. We had quite a dip in February – partly as a result of ongoing concerns about the timing of rising interest rates and partly due to the generally tenuous nature of the markets’ ongoing recovery, mixed with a spate of global unrest for good measure. The U.S. equity markets finished the first quarter of 2014 up slightly as did developed markets overseas, while emerging markets took a bit of a hit. U.S. bonds also increased in value across the board, especially longer-dated bonds. International and emerging markets debt also saw an increase in value over the first quarter.

The upshot appears to be that we continue to ride the wave of Federal Reserve policy that is providing ongoing liquidity to the markets. Both low short-term lending rates and a policy of purchasing longer-dated U.S. Government securities (albeit in diminishing amounts in the last 6 months or so) have helped reboot the economy over the last five years. However, there are some risks to this approach as it enters its sixth year.

As stated by a former manager of the Federal Reserve’s $1.25 trillion agency mortgage-backed security purchase program, Andrew Huszar, in a Time magazine interview from November 13, 2013, “. . . there’s the question of how the Fed unwinds its unprecedented operational expansion. This is an unwinding that will have to be invented on the fly, and it could have huge downside risks for the US economy. . . [T]he Federal Reserve now owns more or less 10% of the overall U.S. housing market, and the equivalent of 30% of the U.S. federal government debt . . .”

There are certainly many possible outcomes and innumerable variables will come into the picture over the next months and years as the effects of central banking policies play out. One thought is that since it can freely manipulate its balance sheet because of the various tools at its disposal and its theoretically infinite investment horizon, the Federal Reserve could simply let the issues mature over the next several decades. That may not be a realistic option, but since they’re making it up as we go along, it’s worth a thought at least.

Another question concerns the impact of a deflationary environment or if the value of those securities and the dollar’s status as the world’s reserve currency were to come into question. Another interesting perspective on the Federal Reserve’s policy of Quantitative Easing (QE) appears in Ryan Avent’s blog and resultant commentary in The Economist from last December as well.

If the Fed is successful in keeping inflation and employment within its preferred ranges however it may do so, the overall economy would benefit from a steady takeoff for the global economy free of major market disruptions. There is simply great upside potential in being able set aside the fear of impending economic disruption and focus on trying to make the world a better place, especially when we are all partners in a faith-based economy and interdependent global ecosystem.

Another potential concern is that the Fed’s policies have created a new or even reprised set of asset bubbles that cannot be supported organically by business or consumer spending or other economic drivers. It goes without saying that the negative impact of another large and sudden reduction in asset prices following so closely on the heels of the two previous market debacles could be significant. However it plays out, central bankers have their work cut out for them as they continue to manage market liquidity with a deft touch.

I’m somewhat optimistic that Janet Yellen and other central bank leaders throughout the developed world can work through the pressing issue of economic malaise. However, central bank policies alone cannot help create just systems of exchange, thriving natural ecosystems and enduring communities. In order to help promote that reality, we need to move beyond a system that elevates short-term wants over long-term needs.

The predominant focus on short-term outcomes also brings up the looming challenge of our resource dependency. While some continue to debate the reality of anthropogenic climate change, the bottom line is that we need to completely restructure our lives around a new set of economic drivers that are not tied specifically to resource consumption but rather to regeneration. I believe that engineering a regenerative economy where self-interest can be realized in the context of broad-based global prosperity and environmental resilience is an opportunity for our generation.

In light of the many enigmatic variables we face, it seems the current trend in increased volatility, or at least more modest growth, may continue until we can establish a more enduring set of economic goals beyond quarterly corporate reports. Some market analysts have suggested earnings growth is projected to decline from recent years, which is not entirely unexpected, given the fact that roughly 70% of U.S. GDP relies upon consumer spending and that consumers’ incomes have remained relatively flat for over a decade and more for many workers. The Economic Policy Institute has an article on the topic.

While we’re glassing the landscape, it’s also worth looking at the CAPE index to gauge longer-term growth trends. The CAPE index was developed by Yale economist Robert Shiller who, according to Stephen E. Wilcox in a September 2011 article in the American Association of Individual Investors, “defines the numerator of the CAPE as the real (“inflation-adjusted”) price level of the S&P 500 index and the denominator as the moving average of the preceding 10 years of S&P 500 real reported earnings, where the U.S. Consumer Price Index (CPI) is used to adjust for inflation. The purpose of averaging 10 years of real reported earnings is to control for business cycle effects.” The long-term average is roughly 16x, suggesting that a reading above this number puts the value of the S & P 500 in the more-expensive-than-average category.

Currently, the ratio is just under 25, which is well below the levels experienced at the height of the Dot Com boom in the late 1990s and early 2000s, and still somewhat lower than what we saw in 2007/2008. Late last year, when the ratio was around 24, Shiller himself cautioned that an above-average reading is not necessarily a signal that the market is on thin ice, rather that longer-term growth will perhaps be more modest.

With spring marking the time of rebirth and reflection, I would suggest that folks take the time to revisit their overall situation and to make sure their current affairs are in line with their personal and financial goals. As usual, short-term financial needs should be accommodated by holding the requisite resources fairly closely, depending upon your personal situation. And if one is particularly concerned about volatility, then taking on additional risk is probably not advisable, recognizing that while trying to time the market is difficult at best, managing risk can be attained by clearly articulating goals and aligning resources accordingly.

Please feel free to contact me with questions or concerns – I would be happy to have a follow up conversation.

All the best,


Bill Stoddart

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