Now we are at the dawn of 2015, which probably will be, at least in my opinion, the year where the Federal Reserve is bound to become the key unintended cause of a further diverging world.
In this context I’ve thought it could be helpful for long-term investors to review a couple of broad snapshots of the Fed’s policy paths since the 1970s and their impacts.
To start with, through the 1970s Fed policy proved consistently lax, which in fact was quite similar to what we have seen during the past decade.
Limiting us to one but very important measure during the 1970s was the average headline inflation rate between January 1971 and the election of Ronald Reagan as president in November 1980 calculated at 7.78 percent on a yearly basis while the average fed funds rate was 7.44 percent or 34 basis points below average headline inflation.
During the two following decades, between November 1980 and December 2001 the average headline inflation rate was 3.79 percent while the average fed funds rate was 6.95 percent, or a completely opposite situation than that of the 1970s.
Coming back to the so-called era of the strong dollar policy that covers the period from 1995 to 2002, the average headline inflation rate was 2.57 percent while the average fed funds rate was 5.28 percent.
Now, if relative Fed policy settings over the past decade proved similar to those of the 1970s, it could be interesting to take look at the performance of the U.S. dollar index, gold and the Dow Jones Industrial Average.
The U.S. dollar index lost about 26 percent between January 1971 when quoting in the 115 zone and in November 1980 quoting in the 85 zone while the dollar also fell 41 percent against Japanese yen over that period.
Over more or less that same time span, gold
rose in dollar terms from $34.95 per ounce on January 1, 1970 to $623.88 per ounce on November 1, 1980 or up a stunning 1,685 percent.
In sharp contrast, the Dow Jones Industrial Average
went over that entire decade literally nowhere as at started at 809.20 on January 2, 1970 and quoted 824.57 on January 2, 1980, but, and this is important, it went through wide swings and high volatility spikes that characterized that decade.
As of recently, there is no doubt the Fed has been very slowly but steadily moving toward tighter monetary conditions and this for most of the last two years.
Besides that and also very important is the fact the Fed’s monetary policy is moving clearly in a completely opposite direction than that of most of the other globally important central banks like the European Central Bank (ECB), the Bank of Japan (BOJ), the People’s Bank of China (PBOC), and some others.
Interestingly this time around, the real clue though could be as to how investors view the Fed in relative terms now appears to be coming from the performance of the markets themselves.
That said and looking back to the past 2008 financial crisis, September 2011 was probably the low point of the post financial crisis era for the U.S. after on August, 5, 2011, Standard & Poor’s
downgraded the United States of America long-term rating to AA+ .
During that summer of 2011, we also had those seemingly endless debates over the debt ceiling in Washington that raised serious doubts about the sustainability of the U.S. financial situation as a whole. But what was maybe even more worryingly for the dollar at that moment in time was the gap (spread) between the headline not adjusted inflation rate and the fed funds rate hitting its widest level since the summer of 1975.
However, since then that gap has been narrowing continuously from 382 basis points to a rather more reasonable 123 basis points, and which interestingly seems to continue on its downward slope.
Compared to the European Central Bank (ECB), the Bank of Japan (BOJ) as well as the People’s Bank of China (PBOC), relatively speaking of course, the Fed appears definitively on its way to a much more hawkish stance than that of its important counterparts and that has had already a positive impact on the dollar index, which is since June 2011 up 23 percent and the Dow, up 51 percent while the spot price of gold has fallen 34 percent.
This compares relatively well to the situation we had in May 1981. Gold at that point was off 41 percent from its January 1980 peak while the DJIA was up 28 percent from its March low and the dollar index had gained 22 percent from its low in the summer 1980.
So, the million dollar question to all long-term investors is: Are making comparisons between now and the early 1980s misleading or wrong? If you ask me, I don't think they are. Maybe, this time won’t be that different as has so many times been the case.
Even if it could take more time than some expect today for the FOMC to actually starting to tighten rates, the very fact that at the FOMC real tightening related discussions are taking place, as was the case at the latest Federal Open Market Committee meeting that concluded on December 17, and where three of its voting members (Richard W. Fisher; Narayana Kocherlakota and Charles I. Plosser) dissented while the other seven members (Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell and Daniel K. Tarullo) voted in favor of maintaining present monetary policy.
This situation alone highlights the fact the Fed is definitively on a completely different monetary policy course than that of most of the other important central banks in the world.
No doubt this will create a lot of volatility for an extended time to come.
Given this it is also worth recalling that 1980 marked the effective start of a 20-year rally in U.S. equities, in which the Dow Jones Industrial Average
started 1980 at 963 and started 2000 at 11,497 which was a more than significant rise of about 1,094 percent .
Over the same period gold
declined from an average price of $615 per ounce in 1980 to an average price of $279 in 2000.
The price of crude oil
also declined as it started in 1980 at an average price of $37.42 per barrel that dipped to an average low of $14.44 in 1986 and ended at $27.39 in 2000.
The dollar, which was intermediately managed lower between 1985 and 1995 by the Plaza Accord that was signed on September 22, 1985 at the Plaza Hotel in New York City, which was an agreement between the governments of France, West Germany, Japan, the U.S., and the U.K., to depreciate the dollar in relation to the Japanese yen and German deutsche mark by intervening in currency markets, nevertheless rose 37 percent between 1980 and 2000.
As always only time will tell if we are really at the dawn of a second, of course, slightly different edition of the 1980s. If that should be the case, lessons from the past could be very helpful for all long-term investors.
Please never forget, nothing goes up or down in a straight line.
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