Humans deal with rain no differently than they do with investments. They have limited faith in the predictions of meteorologists, who in these politically correct times tend to warn of possible hurricanes even when in their hearts they think only of a drizzle. They also tarry, when they have to go on vacation, with travel agencies who describe their destinations as perpetually blessed with a warm sun and a pleasant breeze and pack fans and umbrellas.
While correctly discounting the biases and conflicts of interest of the experts, they do little work on their own to seriously analyze the possible evolution of time. They just look out the window before leaving the house in the morning. If it's raining, they take an umbrella. If it's sunny, they leave it at home, knowing that there's always a small risk that the evening could be useful. If it's cloudy, they look at the sky first and then at the ground.
The decision depends 10 percent on what they see above and 90 percent on what they see below. If it's wet on the ground, they take an umbrella, if it's dry, no. With the same cloudiness of the sky, if it rained in the previous days they take an umbrella much more than if it was nice. In all cases, as can be seen, they are guided by lagging indicators, those that describe the past and not the future.
They could, if they wanted to, always keep an umbrella in their purse (the equivalent of a put option on securities) but the umbrella is cluttered (and the option is expensive) so very often they leave it at home. They know that, at worst, they will find a street vendor with lots of colored umbrellas arranged on the ground under a porch. They are resigned to the fact that street vendors do like Uber, that is, they apply the dynamic pricing model. When it rains, their umbrellas (like the options) immediately cost more, even double or triple, depending on the intensity of the rain. Before finding the peddler, on the other hand, we've already got wet. Nonetheless, there are few who remember to buy an umbrella when it's sunny and when it costs much less (like the options now).
Returning to meteorologists, the only ones who are listened to with extreme attention are those of central banks, even if their forecasts are generally wrong. At the end of 2001, for example, the FOMC predicted that US growth in 2014 would be between 3,4 and 4 percent. Now the official forecast for this year is 2,1-2,3 percent, half that.
Sometimes their predictions are even staggering. In the last three months, the US consumer price index has grown at an annualized rate of 2,8 percent, but the Fed, despite Yellen's saying she is confident (and hopeful) of an acceleration in wage inflation in the coming years , pretends not to see what is under his nose and leaves his inflation estimates for 2016 at 1,6-2,0 percent, even lower than the estimates published three months ago.
The fact that the Fed now expects full employment at the end of 2015 (although it will almost certainly arrive sooner) and that in that situation (by definition optimal) assumes Fed Funds rates at 1,13 with inflation ( which will almost certainly be higher) than 1,75 per cent. Negative real rates of 62 basis points with full employment, an absolute novelty.
Pure financial repression. The market has learned not to be guided by estimates, but by the degree of distortion of reality that they express. Distorting reality, or at least common sense, is the way to express political will. The Democrats of the FOMC, who want zero rates in order to have full employment and wage increases as soon as possible (even at the cost of causing inflation), make estimates of growth in employment and inflation that are clearly low so as to be able to justify the rates at zero.
The Republicans are clearly making them high in order to raise the average and have support to ask for higher rates. Since the Democrats of the FOMC are more numerous (as well as much more influential in terms of opinion) the final estimates, which are an average of those expressed by the various components, are clearly below credible. The more they are below credible, the more they convey the message that the majority component of the FOMC absolutely wants, whatever the cost, to keep rates at zero for a particularly long period.
The markets grasp the message perfectly (and rationally). It doesn't matter that the reality is ugly, with less growth and more inflation (in America) than what we've been telling ourselves for all these months. The only reality that matters is conventional and that reconstructed by the Fed. It so happens that the markets welcome everything and its opposite. In Europe they celebrate too low inflation (because it means that the ECB will do Quantitative Easing) and in America they celebrate high inflation (because it means that the Fed has been successful and because companies finally have the opportunity to raise prices) .
It also happens that the markets become more realistic than the king and express, in their expectations, future rates lower than those, already low, expected by the members of the FOMC. The stock markets can thus continue to rise even if they are starting to be expensive, bonds can postpone the moment of the descent and the dollar can postpone the moment of strengthening, confirming the idea that every time Europe does something expansive, the America responds with even greater aggression.
We talked last week about starting to hedge portfolios. Strategically it remains a rational choice, but after the FOMC we go back to the blackboard and reformulate our idea. Since umbrellas (le put) are expensive, it is useless to buy them too soon. Instead, you could spend the next three to four months selling slightly out-of-the-money calls (at a higher than current strike price) on part of the portfolio. If the calls are exercised we will still have sold the shares at an all-time high, something no one has ever died from.
We will use the accumulated treasure from the summer call sale to buy puts on the rest of the portfolio towards the end of the year. Of two each. Either growth will accelerate more convincingly, and then the market will begin to doubt the Fed's line and go, as is its custom, from an overly complacent attitude to a suspicious attitude (moving down). Or growth will continue to be modest, and then the market will ask whether it is really worth paying more and more for shares that always produce the same income. In both cases, therefore, umbrellas will begin to serve. Après la pluie le beau temps, the French say, and after the good weather the rain.
