The Fed Makes It Official

The Fed recently enacted what the experts are calling a historic policy change. More accurately, it’s the official acknowledgment of what the Fed has already been doing, namely keeping interest low, seemingly forever. What it also means is that it sharply alters the old 60-40 investment mix, to something more like 80-20 or 80-10-10.

The Fed is basically assuming that inflation will be nonexistent – or, at least manageable – for the foreseeable future and is, therefore, willing to let it run “hotter” for longer than it used to before it steps in and raises interest rates. But is that a realistic assumption? Nearly unanimously, Fed officials have been touting the party line that the economy is bad – despite numerous reports that show it is snapping back pretty strongly – and is likely to stay that way or get even worse – which may not be the case. The stock market certainly doesn’t seem to be buying that.

What the Fed seems to be doing is baking in the cake its already oversized role in the economy (and society) and keeping it that way “for as far as the eye can see.”

As I noted in my previous column, cynics might draw the conclusion that the Fed is purposely dumbing down its economic forecasts so as to cement its role for the long-term. Jerome Powell’s streamed announcement at the Jackson Hole summit pretty much made that de facto.

So what does that do for your portfolio? Given that the Fed has now determined that rates will stay low for the foreseeable future, do bonds have any place in your portfolio? What would be the point?

Depending on how long this “new” policy actually lasts, the Fed has laid to rest the classic 60-40 portfolio mix, meaning 60% stocks and 40% bonds, with a couple of percentage points difference, either way, depending on individual circumstances, like age and risk tolerance. With the Fed pretty much making investment-grade bonds a no-win situation – earning practically nothing if rates stay where they are, losing money if rates go up – that leaves stocks and junk bonds and whatever cash you might need.

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Going forward, then, it looks like the standard portfolio will be more like 80-10-10, with 80% in stocks, 10% in high-risk bonds, and 10% (or perhaps more) in cash. (The latter doesn’t earn a return, either, but neither does it lose money).

For the past several years, the “bond” portion of my portfolio has largely consisted of brokered CDs, which don’t earn much but are pretty much guaranteed not to lose money (unlike bonds). But have you shopped for a CD lately? According to the menu at one of the leading brokerage firms, the longest CD on offer is for five years, paying a scrawny 0.4%. Two-year CDs are paying half that or 0.2%. Maturities shorter than that earn even less.

If you can tolerate the risk, that doesn’t leave you many alternatives other than high-quality dividend-paying stocks – many of which are yielding 2% or more – or junk bonds –which pay out more than that, so long as they don’t default.

Ever since the 2008 global financial crisis, the Fed has been criticized for widening the wealth gap between rich and poor through its low-rate monetary policies and asset purchases, which have lifted – some might say inflated – the price of risk assets like stocks by pushing more investors into them. By basically eliminating bonds as a viable asset class, or practically ensuring they’ll lose money, is this the Fed’s way of atoning for its alleged past sins by leveling the playing field between rich and poor?

Of course, this could – and probably will – have the opposite effect by making stocks even more valuable than they are today. If there is no alternative to stocks, then it stands to reason that investors will put even more of their money into equities, especially if they’re confident that the Fed will always be there to act as a safety net, which it said emphatically that it will. That will further drive up equity prices. The rich will only get richer, as they seem to always do.

The adage, “Don’t fight the Fed” has never been more true.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.

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