According to William Safire’s 1982 New York Times column On Language, the term flip-flop took off in the 1940s and was used by political commentators to accuse opponents of opportunism. For example, Richard Nixon’s decision to impose wage and price controls in 1971 even after reviling them for many years. This was criticized as a flip-flop, which he countered with “circumstances change.”
Presidential candidates are the usual targets of flip-flop accusations, but recently the Federal Reserve Chairman Janet Yellen has been targeted. In September 2015, when the market was anticipating rate “lift-off,” Yellen told the post-meeting press conference that due to “heightened uncertainties abroad and slightly softer expected path of inflation, the committee judged it appropriate to wait for more evidence.” A Bloomberg column followed, Yellen’s Flip-Flop Isn’t Guidance. The delayed initial rate increase occurred in December 2015. Shortly thereafter in early 2016, worse than expected economic data was reported and market participants correctly judged that the Fed would probably leave rates unchanged in March, contrary to its previous outlook of an increase.
Mixed U.S. economic data and sluggish growth across the globe have resulted in heightened uncertainty, a stock market that has fluctuated in a fairly wide trading range of greater than 10%, and an increasingly dovish stance from Fed Chairman Janet Yellen since December 2015. In late March 2016 Yellen explained why the Committee expects only gradual increases in the federal funds rate in the coming years. A summary follows:
Low unemployment; labor market added 230K jobs/month the last 3 months
Consumer spending expanding at a moderate pace. Driven by: income gains, improved household balance sheets, wealth effect of stock market, and low oil prices
Slow global growth & U.S. dollar appreciation have weighed on manufacturing, net exports, business capital investment
Large scale layoffs in energy and adverse spillover effects
Then just three days later on April Fool’s Day, a jobs report exceeded expectations and caused the futures market to place a better than 50% chance for a rate increase in September. This was a change compared to prior expectations of no hikes until December.
We would not be surprised if circumstances regarding the U.S. and global economy continue to change, resulting in what appears to be a flip-flopping Fed Chairman. In our view, the most likely short-term result of these potential flip-flops is continued and pronounced market fluctuations until a sustained trend (up or down) takes hold medium-term. Notably, Bloomberg recently reported that combined with short interest, asset managers are positioned the most bearish since October 2011. This out-sized negative sentiment could propel the market significantly higher should any surprisingly positive developments occur. In our view, and as we have previously written, this persistently negative sentiment has contributed to the duration of the current bull market and market declines provide opportunities to increase stakes in quality companies on temporary discounts.
A recent white paper published by global investment management firm GMO evaluated the impact that Federal Reserve meetings have had on the U.S. stock market (S&P 500). In a fairly straightforward exercise, James Montier and Philip Pilkington examined the total return of the S&P 500 compared to the total return excluding the days of FOMC meetings.
They found that during the period 1964 to 1983 there was no effect. However, from 1985 onward, removing these days actually began to show a major impact. Surprisingly, since 1984, FOMC meeting days have accounted for 25% of the total real return of the S&P 500. Furthermore, the direction of the rate change announced on these days had little to no consistent impact on the direction of the daily market return! It appears that the Federal Reserve has had a major positive impact on the stock market returns, just by meeting and removing uncertainty.
Knowing What’s Important
David Sklansky’s book entitled Getting the Best of It!, is a treatise for gamblers that explores the mathematics of gambling, probability and decision making. We are not implying that gambling and investing are identical, but there are similarities, especially when evaluating probabilities, behavioral fallacies, and risk/reward concepts. In one of Sklansky’s last chapters titled Knowing What’s Important, he writes, “Often the game is too complex for one person to learn everything. It stands to reason, then, that the goal should be to learn as many of the right plays as possible. The more often you are right, the more often you will win. Unfortunately, this is not quite correct. It is possible that you will know a higher percentage of the proper plays without playing as profitably as someone who knows less. The reason this can happen stems from the fact that not all plays are equally important.” This idea of not all plays are equal is a key point at Redmond Asset Management.
We stay aware of the probabilities of future interest rate changes; we have a broad sense of the overall economic environment, and inevitability form opinions about the likely short-term stock market action. However, all have low importance to how we invest your capital and our long-term investment returns. While there are infrequent times when a Fed strategy could have a significant impact on stocks, or economic deterioration causes us to take a more defensive portfolio stance; by far the most important thing to our long-term success is consistently applying our investment philosophy of owning shares in quality companies with durable competitive advantages, capable management, high profitability, and sound financial strength. We stick to seeking out the best risk-adjusted long-term equity investments that we can find, irrespective of Federal Reserve Policy, global economic data, or short-term market outlook.
We hope that you have had a chance to review the Summary Updates booklet that we sent you in December and look forward to catching up with you in 2016. Please do not hesitate to contact us if you would like to discuss your portfolio holdings or any other topic.