Markets soared on a wing and a prayer yesterday, as the Dow put on over 200 points, enjoying its biggest daily rise for over a year, and yet the euphoria seemed to be a good deal more irrational than anything the dot com era could have thrown up.
A lot of the problem at the moment, say some people, lies with Ben Bernanke. The new Fed governor is spreading confusion and markets reacted the way they did yesterday because of a couple of ever so slightly optimistic words the Fed uttered.
They criticise Bernanke for sending out mixed messages. Gone are the days of Alan Greenspan, when everyone knew that they didn’t know where they stood. Instead today, they are just not sure, and that, say the blamemongers, is why the markets are in such a state.
The truth is, however, markets and the analysts who blame “Blunt Speaking Ben” are the ones being inconsistent, or at least showing little understanding of a basic law of economics.
The law they don’t get is this: Economics is not an exact science. Ben Bernanke probably knows his economics better than almost anyone, but he doesn’t have all the answers. Mr Bernanke says what he thinks, but his thoughts, like those of any objective economist, are based on possibility and probability levels, and are far from certain. Markets don’t like it when they find that out.
Alan Greenspan, on the other hand, liked to keep markets guessing, but kept his doubts to himself. At the time, they criticised him for being too subtle, and not open enough. Ben’s big mistake is this: he isn’t God, and he has as good as admitted it. There are limitations to his prescience, and rather than hide this, and use a veil of subtlety to keep markets thinking he knows more than he does, he says it like it is.
Yesterday the Fed did what most expected it to do, and upped rates a quarter of a percent. “Phew,” said the markets, “rates didn’t rise by half a percent, which we really weren’t expecting anyway and, as a result, let’s go out and buy.”
The statement from the Fed said: “Ongoing productivity gains have held down the rise in unit labour costs, and inflation expectations remain contained, and economic growth is moderating.” Markets really liked those comments, (although the statement said nothing we didn’t already know) and went out and bought even more.
The Fed also said: “However, the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures.” Or in other words, there are still strong inflation risks, and we might well up rates again. Markets chose to ignore those implications.
Inflation really does matter. If it continues to mount, and the rate of interest is forced to rise to counteract the threat of rising prices, then it will be a nasty shock for the economy and all those debtors who borrowed when rates were rock bottom. The savvy investor will keep his or her eye on this, and not jump every time the Fed snorts.
© Investment & Business News 2013