Monday, February 18, 2008

All Whine, No Cheese

It looks like the Fed has thrown a party and no one has bothered to come. No RSVP, no regrets, just nobody at the punch bowl. The double barreled 1.25% decrease in interest rates last month was the fastest since the Fed Funds Rate become the principal policy tool in 1990. Still, the cost of credit has increased for companies and households in the past few weeks.

As financial companies have struggled with the uncertainty of underlying asset values, they have increased the spread they require to lend even to the most solvent of customers. The fed funds interest rate may be lower, but the risk premium has soared to offset any benefit. The market has been tightening credit as fast as the fed has been loosening. The net result is a credit system in lock up.

The failure of monetary policy has led now to the fiscal stimulus package of some $168 Billion intended to prime the pump. Until the checks actually get into individual hands later this year, the debate will rage over the effectiveness. The last time such a package was used, about two thirds actually went to consumption stimulus. How much this time will be added to GNP enhancing consumer appetites and how much will be used to pay down debt is an open question.

A recent poll indicates 19% of recipients intend to spend the rebate, 45% will pay debt and 32% will invest the rebate. What will then be effectively a $32 Billion dollar injection to the economy is only slightly less than the current losses declared by Merrill Lynch and Citibank, just two of many banks with toxic debt on the books. The package looks more like a political inoculation for congress than a serious effort to set the economy back on a steady course.

The next administration, Republican or Democrat, will be facing decisions likely to be politically untenable but necessary, at least ultimately. Decisions about national priorities cannot be put off much longer. As a nation the debate will rage on such issues as whether the greater and more likely terroristic threat is an unexpected and unaffordable illness or an unexpected attack by misguided religious zealots.

The nature of national risk perception is no different than investment risk. Catastrophic risk is often given greater credence than more common risk. Many of us will not travel by air yet step without hesitation into the shower, even though the shower is the riskier proposition. Likewise investors look at risk of losing money in an investment as inherently greater than the near certainty of risk to purchasing power from inflation.

At a time when the risk constellation for investors is particularly muddled, there is no clear answer to the question of the “right” investment. Now more than usual, having a widely diversified portfolio balanced to strategic allocations is the best tactical approach. US Stocks, Foreign Stocks, Gold, Commodities, Bonds, Large Cap, Small Cap, Real Estate, Municipal Bonds, hedged, leveraged, cash? Regardless of the fact that the airwaves are full of predictions, it’s largely noise in a confused financial world. The past few years have muddled the historical correlations, and in some cases stretched valuations. Now is the time for patience. We will let the market tell us how and when the next boom or bubble will appear and in the meantime try to select the best choices for cost and risk within a wide diversity of investments.

As clients know, we are strategically adding to several asset classes and paring back on several others as we try to both look beyond the horizon and watch that we don’t step in anything nearer.

John F. Barnyak
Stonehouse Asset Management