Don’t fight the secular cycle

Every day people regurgitate trite sayings without much thought. It seems typical of humans. Probably because there is comfort and reassurance in old sayings and comfort is what we crave in a world of change. Often this can be harmless. But, when blindly adopted as financial truth, this habit can be dangerous.

One such example is the old saw “Don’t fight the Fed.” This was originally used as a cryptic line to express the reality that if central bankers wish to lower short-term interest rates they have traditionally had monetary tools with which to do so. And for 30 years from 1982 to 2012, the central banks of the world have cut interest rates to increase money supply and entice discretionary consumption on credit. During those three long decades (a near lifetime for the Boomer generation) the most obvious manifestation of “Don’t fight the Fed,” has been in the bond market, where existing bond prices have increased substantially every time Central Bankers have slashed short term rates. Dividend paying stocks increased in value to a lesser extent but for the same reason (dividend income is not contractually required and so riskier than bond interest, but payments made do become more valuable each time prevailing interest rates fall). So the price people were willing to pay for stocks went up as interest rates fell. (Actually bond gains have beat stock gains for most of the past 200 years thanks to compound interest, but few people are interested in such facts. See this chart for more.) I digress. The fact is that in a financial world paid to sell the hope of stock wins, the sell side has seized on “Don’t fight the Fed” as the perfect mantra to keep new hopefuls perpetually flowing their capital into stocks. (All the while the same stock promoters have said bonds were for losers even while bonds beat stock returns.) But again, I digress.

The hard point is that most people today have insufficient savings and so opt to wager on blind luck and improbable wins: lottery tickets, gambling and stock markets at every price, regardless of the likelihood of retaining profits. A whole gaming and financial business has evolved in response to the preference for financial fantasy. Marketing to this demand, most in the money business are paid to promote the hype and hope of capital wins at all times and every price.

But as always, timing is everything, and today is the opposite of 1982. Today North American government bonds are not paying an anomalous 20%. Today rates are less than 2%. In 1982 the Fed had the luxury of two deciles of percentage points of stimulus to draw on. Today they have literally none. Developed world Central Banks are already paying virtually nothing today on overnight deposits. Some like Germany and the Netherlands are actually charging negative rates. When central banks had run to the end of their lower rate rope by 2010, and no traditional consumption rebound had revived, they resorted to last-straw desperate measures known as “quantitative easing”. For the past two years they have used this publicly funded purse trying to spark the flame of organic economic growth repeatedly to no avail. The stock market has sputtered through fits and starts each time with no lasting benefit. This chart of the downtrend of the Global PMI manufacturing index (blue) and the ridiculous and fleeting failings of the MSCI world stock index (gold) since 2010 says it all.

So back to a simple but crucial point about “Don’t fight the Fed.” The Fed has exhausted its monetary efforts of import. After 30 straight years of slashing rates in response to each period of stagnant growth, Central Banks are out of demand catalysts to throw at the economy. The now over-levered world has strung itself up in debt. The new mantra should now be “don’t fight math” or “don’t fight the secular demand cycle”. Either way it seems that the mindless magic of ‘add credit and stir’ is over for the next few years.

And finally coming full circle, if the US Fed is now impotent, then the US dollar should continue to strengthen in relief. And this should continue to undercut the assets that have enjoyed outsized gains on U$ weakness over the past 10 years. This would suggest further weakness for equities, commodities (including precious metals) and other “risk on” currencies like the Canadian dollar.

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17 Responses to Don’t fight the secular cycle

  1. JW says:

    Well said. One of the tools that Mr. Fed has left is to talk down the yields. Is 2% on the 10 year treasury the new top “allowed” by the Fed.? Thanks. Langley, BC

  2. Attila Balazs says:

    ” (Actually bond gains have beat stock gains for more than 200 years thanks to compound interest, but few people are interested in such facts.)”

    Sorry, but it’s not true.
    And Prof. Siegel would argue otherwise too.
    Also this little research .

  3. Attila Balazs says:

    The Fed’s current balance sheet was released this week. It shows that as a result of those QE programs the Fed is now holding $1.66 trillion in U.S. Treasury bonds, and $926.7 billion in mortgage-backed securities. But it had pledged to continue the program through 2013 (or until the economy improves enough to have the unemployment rate down to 6.5%). At the current rate of purchases, that would mean the purchase of an additional $1.02 trillion of Treasury bonds this year.
    The need for this degree of asset purchases was not envisioned in the beginning. Yet even with the earlier totals, many economists wondered how the second half of the grand experiment would eventually be worked out. That is, how would the Fed manage to eventually reverse its efforts and sell those assets off its balance sheet without driving interest and bond yields sharply higher, bond prices sharply lower, thus hurting the economy and bond investors?
    I think already someone is beating the Fed to the bond exit door. The selling has the 20-year bond already down 11% since July. And now the Fed’s release of its FOMC meeting minutes this week is likely to put more pressure on bond-traders and large institutional holders to bail out of bonds even faster in order to stay ahead of further selling pressure that might result from the Fed halting its supportive bond-buying earlier than previously thought.
    Look out below for bonds?

  4. Gary T. says:

    When you say ” the central banks of the world have cut interest rates to increase money supply…”
    How does that increase money supply? It might encourage speculation (and punish savers) – which, btw, does not build an economy but the only way they increase M1, M3 is printing more. No?

  5. Prof. Siegel is a hired shill for the long always stock firms. He openly thanks them for all of their support in the intro to his book “Stocks for the long run” which helped to financially annihilate many a follower’s savings since it was published in the late ’90’s. See: for more. I have some other historical charts I will look up and post shortly.

  6. rolling stall says:

    Well put Danielle. But may I add to ‘timing is everything’…have you given thought to the emerging bonanza of fracking shale gas and oil to the American economy? If you dive into certain sectors, they are doing quite well. There really is a bonanza of an energy boom coming, so large that I do now believe the US dollar is going to start showing the coming energy supplies and I do now believe this dollar move is going to greatly affect ‘gold’, but to my long held dismay….to the downside. I doubt 700, but anything is possible. My bets are on the reverse flow pipeline stocks, manufactured housing and certain fracking fields although this is very early on, but the market is placing their bets. I can just feel it. Care to comment?

  7. Attila Balazs says:


    Waiting patiently for some independent, historical evidence.
    In the meantime, should I ask Rosenberg?

  8. Attila Balazs says:


    According to my first comment (see it right below JW) this is the exact and original sentence of yours what I argued with:

    ” (Actually bond gains have beat stock gains for more than 200 years thanks to compound interest, but few people are interested in such facts.)”. – before you altered it to this:

    ‘ (Actually bond gains have beat stock gains for most of the past 200 years thanks to compound interest, but few people are interested in such facts. See this chart for more.)’

    After careful reading I noticed a very different meaning between the two. Can you see it too?
    Therefore, as the original argument is concerned, I was right and you were wrong.

    Looking at the following academic research I think that Prof. Siegel is right on the mark as well.


  9. Yes I amended that sentence to reflect the price chart of bonds that I added on your request for more data. But the price movement is not the whole story. Once we divide price moves by volatility, bonds have beaten stocks for risk adjusted returns over the whole period. This is critical because people react very badly to high volatility price swings and tend to sell stocks near bottoms and buy near tops. All of which makes their net results much worse than a 200 year price chart appears. This is another key reason why bonds have beaten stock returns for real life holders. Add to that the fact that 200 year time frames are actually irrelevant in terms of individual experience. Bonds have outperformed stocks for 30 and 40 year periods on a gross return basis several times through long secular cycles, if this happens to be the 30 or 40 years we are investing our savings then that is the thing that matters most, not what theoretical returns are before or after our life span. And as for Siegel as a source, as I said… shill–not worthy.

  10. Andrew says:

    Useful article and comments.
    PIMCO is heavy in cash and is lowering duration of portfolios significantly and has taken constructive approach to inflation with lots of TIPs.

    My question to Danielle is how is your shop timing the bond allocation of your portfolios?

  11. Barry says:

    Rather than declaring who may be wrong or right on the issue of bonds versus equities I contend that timing, geography and patience are crucial. Buying an Austrian or German government bond in June, 1914 on the London Exchange when they were at par would end in disaster.

    Certainly bonds had a fabulous run since 1981. On the other hand as Buttonwood says in a recent Economist column “In real terms, an investor who bought Treasury bonds in 1947 had seen their purchasing power fall 90% by 1981”.

    Select dividend paying stocks have also done very well during the past decade if you had the courage to hold through the bad and the good – CN Rail, Fortis, Enbridge, TD, McDonalds … they’ve all beaten the index handily during this secular bear. And the tax efficient income they throw off is growing … passively.

    What’s important is to learn when to buy ANY asset class when they are cheap, and to avoid the shills who proselytize their book.

  12. Attila Balazs says:

    Fine, so you don’t like Siegel (neither do I), but Ibbotson and Chen came to the same conclusion in July 2009. Also Siegel mentions Prof. Shiller in his book (Stocks for the long run) as one of the contributors.
    We have to give him credit.
    Oh, and remember; ‘In the long run, we are all dead.’ (J.M.Keynes)

  13. you are correct, unless banks then loan out money into the real economy (and companies and individuals have to want to borrow and spend) there is no multiplier effect from cutting rates. But that is the theory that central banks espouse for loosening monetary policy, ie., to increase money supply through the real economy.

  14. We use big picture yield and money flow analysis to gauge our bond allocations ie., as to what duration, quality and type of bond. Presently we are rolling money over as it comes due in the 1-5 year category. The long bonds 20 years+ may well see big capital gains again if the flight to quality and slowing growth drives more capital back to “safe havens” in 2013, but the long bond is already very expensive and so very volatile at this point. Few people are built to take that kind of volatility on their fixed income side.

  15. Attila Balazs says:

    Speaking of history, let’s remember for a moment what happened at the end of WWII. to the German mark and bonds issued by the Third Reich ?
    They were all gone, completely worthless.
    On the other hand, what happened to the German arms manufacturers, like Krupp, Mannesmann, IG Farben?
    Well, they survived the war and they still carry on their business even today.
    (IG Farben defunkt in 1952)
    By the way, in the discussion above, did we mention inflation at all?

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