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The Sandy Spring Way

I am the Federal Reserve, hear me roar.

September 17th, 2012 | By Beau Mercer

I am the Federal Reserve, hear me roar.
Printing dollars in numbers too big to ignore.

With an apology to Helen Reddy for paraphrasing her early 1970’s anthem, the Federal Reserve dropped a bombshell on the markets last week, and the reverberation may endure for years to come.

In an eagerly awaited announcement, the Fed launched another round of money printing and said it would start purchasing an additional $40 billion per month in agency mortgage-backed securities. This, on top of an existing debt buying program, will add about $85 billion per month to the Fed’s balance sheet through the end of this year. While that part of the announcement was not too surprising, the twist that turned investors’ heads was the following two excerpts from the Fed’s statement.

  1. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.
  2. The Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.
    Source: Federal Reserve

The Fed did two new and astonishing things in these excerpts. First, they made this intervention “open-ended” whereas in the past, they put a fixed dollar amount and time frame on it. Second, they said the intervention would continue long past the time when the economic recovery strengthens, which suggests the Fed may keep pumping the economy full of gas even if the tank is already full.

With this aggressive action, two words come to mind—unintended consequences. Already, we’ve seen commodity prices, precious metals, and long-term interest rates rise and the U.S. dollar slump. To take a quote from Aldous Huxley and, before him, William Shakespeare, we’re in a brave new world with these moves, and as your advisor, we’re doing our best to succeed in it.

Data as of 09/14/12 1-Week YTD 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks)

1.9%

16.6%

23.3%

11.8%

-0.3%

5.1%

DJ Global ex US (Foreign Stocks)

3.8

11.0

9.7

2.3

-4.8

7.4

10-year Treasury Note (Yield Only)

1.9

N/A

2.0

3.4

4.5

3.9

Gold (per ounce)

2.8

12.8

-2.4

21.1

19.9

18.9

DJ-UBS Commodity Index

3.2

8.1

-4.8

7.0

-2.5

3.6

DJ Equity All REIT TR Index

1.6

21.3

28.6

22.6

4.0

11.6

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

“SITUATIONAL AWARENESS” IS A MILITARY CONCEPT

“Situational Awareness” is a military concept that has some applicability to our role as a financial advisor. In the military sense, it’s defined as:

Knowledge and understanding of the current situation which promotes timely, relevant, and accurate assessment of friendly, enemy, and other operations within the battle space in order to facilitate decision making. An informational perspective and skill that fosters an ability to determine quickly the context and relevance of events that are unfolding.

Metaphorically, you could consider Wall Street the “battle space” replete with friends, enemies and all kinds of noise and news that may or may not affect the battleground. Making sense of all this cuts to the heart of situational analysis.

Not surprisingly, there’s a process to situational analysis. Air Force Colonel John Boyd developed the OODA Loop in the 1950s, which stands for Observe, Orient, Decide, Act. Through this iterative process, military folks observe a situation, process what it means through orientation, decide on a course of action, and then act to solve the problem. Similarly, financial advisors use a process to analyze incoming information and then take action.

In theory, this sounds like a reasonable way to make decisions in a complicated world. And, for many years, it worked for the military and advisors alike. But guess what? Times change. As the military realized, the world is evolving from being merely complicated to the more nebulous complex; one characterized by more ambiguity and hyperspeed in information.

In today’s complex financial world, the OODA Loop process has lost some effectiveness. To evolve with the times, we have to become better critical thinkers. We have to challenge more assumptions and offer alternative scenarios. We have to think about unintended consequences and potential “Black Swan” events. We have to get comfortable in making decisions in a world of uncertainty and ambiguity.

Will we always get it right? No. But we can assure you we are continuous learners and strive hard to make effective decisions on your behalf.

Weekly Focus –Think About It…

“Complexity is the prodigy of the world. Simplicity is the sensation of the universe. Behind complexity, there is always simplicity to be revealed. Inside simplicity, there is always complexity to be discovered.”

–Gang Yu, PhD, Associate Professor,
UT Southwestern Medical Center