Economists: Your New BFFs

Economists: Your New BFFs Applied Investment Management Fall 2014

Held article: “Why It Is (Still) All About Sectors” “Sectors are truly unique economic entities.” - Each responds differently to : 1) the ebb and flow of the business cycle 2) changes in government policy (example: Affordable Care Act -- healthcare) 3) improvements in technology (example: fracking – energy) - Average annual difference in return between best and worst sectors is 50%! Held’s recommendation: Carefully manage sector exposure.

What are our 4 biggest sector exposures in the Regents’ portfolio? • Information technology (IT) and Materials: These arethe most over-weighted relative to the S&P 500 benchmark’s sector weights • Our active return is hurt if these do WORSE than other sectors - Financials and Consumer Discretionary: These arethe most under-weighted relative to the S&P 500 benchmark’s sector weights - Our active return is hurt if these do BETTER than other sectors

Fidelity article: “How to Invest in Sectors Using the Business Cycle” “At any given time, asset price fluctuations are drive by a confluence of various short-, intermediate-, and long-term factors.” “For this reason, adopting a comprehensive asset allocation framework that analyzes underlying factors and trends among the following 3 temporal segments can be an effective approach: - Tactical (one month to 12 months) - Business Cycle (6 months to 5 years) - Secular (5 to 30 years) (per Wikipedia: “A secular market trend is a long-term trend that lasts 5 to 25 years and consists of a series of primary trends”. We’ll look at Long-Term or Secular Trends in a few weeks.) Fidelity’s recommendation: Know what sectors to avoid!

Fidelity article (continued)

Fidelity article (continued) Implications for us: • Watch for signs of business cycle moving from MID phase to LATE phase. • Watch economists forecasts and leading economic indicators • Watch money flow indicators (i.e., are professional money managers taking money out of IT investments and putting it to work in Financials?)

Economists There are lots of them out there and they are easy to find! • Examples of some that we’ll watch in here: • Wall Street Journal’s monthly survey of economists. • (The link to the latest is in your Instructions for Assignment 1 page 1.) • Wells Fargo’s economists’ web site • https://www.wellsfargo.com/com/insights/economics/ • Other economists of your choice. • The Fed. (Why worry about what the Fed does?)

From “Global Woes Fail to Send Cash Into U.S. Stocks: Further Selloff Could Put Stocks on Track for Correction,” Wall Street Journal, Jan. 26, 2014, by Tomi Kilgore and E.S. Browning

The Federal Reserve (“The Fed”) and Quantitative Easing (“QE”) • Many believe that the Fed’s QE is responsible for the dramatic outperformance of the U.S. equity (stock) asset relative to the dramatic underperformance of the U.S. bond asset in the past few years • A Quick Review: 1) What’s the difference between “sectors” and “assets”? 2) What’s the difference between asset allocation decisions and sector allocation decisions? 3) Which assets are we allowed to invest for the Regents?

The U.S. Federal Reserve System • “On December 23, 1913, the Federal Reserve System, which serves as the nation's central bank, was created by an act of Congress. The System consists of a seven member Board of Governors with headquarters in Washington, D.C., and twelve district Reserve Banks located in major cities throughout the United States.” • Which district is New Mexico part of? Kansas City http://www.kansascityfed.org/ • Cite and more information at: http://www.federalreserve.gov/pubs/frseries/frseri.htm

Quantitative Easing (“QE”) Was Begun by Then-Chairman of the Federal Reserve Ben Bernanke in 2012 • “Ben S. Bernanke began a second term as Chairman of the Board of Governors of the Federal Reserve System on February 1, 2010. Dr. Bernanke also serves as Chairman of the Federal Open Market Committee, the System's principal monetary policymaking body. He originally took office as Chairman on February 1, 2006, when he also began a 14-year term as a member of the Board. His second term as Chairman ended January 31, 2014, and his term as a Board member ends January 31, 2020. • Before his appointment as Chairman, Dr. Bernanke was Chairman of the President's Council of Economic Advisers, from June 2005 to January 2006.” • There are 7 members of the Fed Board (“governors”). http://www.federalreserve.gov

http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/districts/http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/districts/

“Helicopter” Ben Bernanke

“Helicopter Ben” Speech Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C.November 21, 2002 http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm Deflation: Making Sure ‘It’ Doesn't Happen Here “With inflation rates now quite low in the United States… some have expressed concern that we may soon face a new problem--the danger of deflation, or falling prices. That this concern is not purely hypothetical is brought home to us whenever we read newspaper reports about Japan, where what seems to be a relatively moderate deflation--a decline in consumer prices of about 1 percent per year--has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors.”

“Helicopter Ben” Speech (continued) Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C.November 21, 2002 http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm Deflation: Making Sure ‘It’ Doesn't Happen Here “… But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

“Helicopter Ben” Speech (continued) Why is this referred to as the “Helicopter Ben” speech? “Fiscal PolicyEach of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money.”

“Helicopter Ben” Speech (continued) What is Bernanke referring to with respect to “Milton Friedman's famous "helicopter drop" of money”? “Friedman was the main proponent of the monetarist school of economics. He maintained that there is a close and stable association between inflation and the money supply, mainly that the phenomenon of inflation is to be regulated by controlling the amount of money put into the national economy by the Federal Reserve Bank. He famously quipped that deflation can be fought by "dropping money out of a helicopter". http://asderathoslchaimclassicalliberalism.blogspot.com/2010/03/milton-freidman.html

Bernanke’s 2012 Jackson Hole Speech Remarks by Governor Ben S. Bernanke at Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming.August 31, 2012 http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.htm • In Bernanke’s August 31, 2012, Jackson Hole speech, he makes statements that made many economists conclude he still believed in fighting deflation by “printing money.” Following the speech, the Fed, under Bernanke’s leadership, expanded a policy of quantitative easing (“QE”). • What were the stated objectives of Bernanke for asset prices? (Consider stocks, bonds, and cash.) STOCK and BOND PRICES INCREASE; interest rates for Treasury and Corporate bonds remain low. Little to be gained investing in T-bills and money markets – so investors put their cash into stocks, bonds, real estate, etc. • Since the speech, has QE have the effect Bernanke wanted? Answer: see slide #9. • If “printing money” drives up asset prices, why not “print money” all the time? What are the risks?

Federal Reserve Chairman Janet Yellen

Don’t worry Ben, I got this!

Before Monday’s class begins, please do the following and prepare to discuss in class: 1) Read Ben Bernanke’s Jackson Hole speech from 2012 (see slide 19 for the link). Develop an answer to question 4 on slide 19. 2) What’s the current status of Quantitative Easing? 2) Watch the Bloomberg interview: “What will Janet Yellen say at Jackson Hole?” http://www.bloomberg.com/video/janet-yellen-what-will-she-say-at-jackson-hole-e_EpsVk1RnmYcU5o05uN7Q.html 3) Once Janet Yellen has given her speech Friday at Jackson Hole, search the Fed’s website for a press release of her speech and read it. For example, try using Google to search for Janet Yellen 2014 Jackson Hole. Or it might be posted by the Fed at: http://www.federalreserve.gov/newsevents/speech/2014speech.htm 4) Then read media reports (e.g., WSJ, Bloomberg, CNN, Financial Times) and market experts and see what they say about Janet Yellen’s remarks.

Economists: Your New BFFs