Kopernik: What It Sounds Like When Doves At Fed Cry

Introductory Thoughts to Ponder

“Information is the part of a message, data set picture, or group of sounds that is not predictable.” – Claude Shannon

If a tree falls in the forest, and no one is around to hear it, has there been a sound?

If the quantity of money quintuples, and the CPI fails to “hear” it, has there been inflation?

“The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. The process by which banks create money is so simple the mind is repelled. With something so important, a deeper mystery seems only decent.” – John Kenneth Galbraith writing in ‘Money: Whence it came, where it went’ (1975)

“’Safety’ is a tricky and paradoxical concept. The safe assets are often the ones that people regard as hopelessly risky.” -Jim Grant

Do the doves view the rest of us as pigeons?

After a quarter-century of increasingly profligate policies at the Federal Reserve (Fed), and with prominent dove Janet Yellen now ascendant to the throne at the already ultra-dovish FOMC, we will hear, with increased amplification and clarity, “what it sounds like when doves cry”.

Kopernik: What It Sounds Like When Doves At Fed Cry

Investment Management is a great field. We’re always learning interesting things, interacting with fascinating people, searching for diamonds in the rough, and given the opportunity to enhance the livelihood of people, foundations, endowments, retirement plans and others. We are blessed! Value-oriented investing is often easy, like being the house in a casino game. While the players always seem to be having all the fun, the house lets the laws of mathematics work their magic. So it is with investing. The “players” seem to be having all the fun, while the value investors patiently wait for the laws of mathematics and economics to accrue to their benefit. They always do.

At the casinos, occasionally someone gets “hot” with the dice. They continue to “roll the numbers”, pressing all the way. Everyone at the table hoots and hollers while raking in the dough. The party can go on and on, while the house takes quite a beating. But, eventually the high roller “sevens-out”, instantly losing back a good portion of their winnings. From there, the house meticulously makes back some more, and some more, and ultimately ends up well in the black.

So it is with value-focused investing. Though it is so easy most of the time, it can be intolerably painful during those episodes where the momentum players get a “hot hand.” “Investors” begin to feel lucky. After a period of time they feel confidently lucky. Eventually they become arrogant. Participants willingly suspend disbelief. The laws of mathematics and economics are brushed aside as people see increasing “evidence” that the stocks of the cherished companies only go up, while the stocks of unpopular companies don’t. Often they go down because in order to buy more of the hot stock, sector or ETF, funds are raised by dumping everything else. The expensive get more expensive while the bargains get cheaper still. Toward the end, when it seems that irrationality has maxed out, it actually accelerates, becoming parabolic. Never is it more important, than at these moments, for investors to not lose their conviction in fundamental investing. To jump on the popular stocks just before the “players” “seven-out” is tragic. To sell the underperforming stocks before all the money comes pouring back toward value propositions is unfortunate, to say the least.

Japan had a colossal financial bubble in 1989. During my lifetime, the U.S. has had three: the Nifty-Fifty in 1972; the Technology, Media & Telecommunications (“TMT”) mania of 1999; and now. 2007, in my opinion, was merely a precursor to our current predicament. “Too big to fail” institutions became bigger still. Asset prices are generally all higher than their lofty levels at the top of the last peak. Debt levels are way higher now. Because we believe the bond market is undoubtedly the most overvalued market in the history of mankind (many $Trillions) and because it has been spilling over into stocks, housing, art, collectibles, healthcare and others, now is an important time to talk about financial manias. Even though Prince likely wasn’t thinking of the stock market back in 1984, when he penned the lyrics about the collapse of 2000 and the preceding party of 1999, his songs still serve as a good source of inspiration and analogy.

Fed Debt securities

Back in the 1980s, when I walked out of the movie Purple Rain because I disliked it, I never would have anticipated using it as an allegory to describe the 2014 investment environment. But I guess I wouldn’t have expected the world to evolve into one where the eccentrics are the sane ones.

See full Kopernik: What It Sounds Like When Doves At Fed Cry in PDF format here.