David Kotok: Extraordinarily Bullish

November 12, 2012

There is some post-election clarity. Markets are presently ignoring it.


“The Supreme Court of Monetary Policy” is the Federal Reserve of the United States. It has seven governors and 12 presidents. The seven governors and the president of the Federal Reserve Bank of New York vote on monetary policy all the time; the other 11 presidents rotate. Four of the 11 presidents vote at any one time. The decision-making authority is the Federal Open Market Committee (FOMC), with 12 voters at any one time.

Let's count the votes: Seven governors and President Obama controlling the appointments. The Democratic majority in the Senate confirms them. In fact, Obama's support in the Senate has grown. The threat of filibuster, or blockage by senators, has been reduced.

The monetary policy of the U.S. during the Obama administration is the Bernanke policy. Bernanke has clearly established a long-term policy of next-to-zero, short-term interest rates and exceptionally and persistently low longer-term interest rates. Bernanke has delivered precisely the policy he promised. He has had the majority votes of his board and many of the presidents supporting him.

Although Bernanke is willing to tolerate dissenting votes and has had as many as three FOMC members oppose a policy move, the majority and the overwhelming, established position of the Federal Reserve is Bernanke's policy. Bernanke's term will end a year after the inauguration of our re-elected president, but the Bernanke policy will continue. The successor appointees to the Federal Reserve Board of Governors will be made by the president who appointed most of the present board and who fully supports the very-low-interest-rate policy.

What is clear from the election outcome is that the interest-rate policy of the U.S. is likely to be defined for the entire Obama second term.

Markets are ignoring this idea. They do not want to accept a very-low-interest-rate policy for a protracted period of time. Markets are also ignoring the fact that the same policy is in play in nearly all major mature economies of the world. In some of those economies, the interest rates are negative. In others, they are near zero. In nearly all cases, the long-term interest rate is somewhere between 1 and 2 percent. In some cases, it is less than 1 percent.

When you price financial assets, hard assets, real estate, precious metals or any type of assets, you must compare the expected return of the particular investment with the riskless return you can obtain from high-grade sovereign debt. We see high-grade sovereign debt, be it the U.S. dollar in U.S. Treasurys, euros in German sovereign debt, yen in Japanese sovereign debt, the British pound in British sovereign debt or the currencies of Sweden or Switzerland or Singapore. Wherever you look, the interest rates on riskless, highest-grade sovereign debt are very low. Note that in the U.S., the high-grade tax-free money market fund in your account pays 0.01 percent. The high-grade taxable money market fund also pays 0.01 percent.

We expect this low-rate environment to translate into very aggressively rising stock prices in the next few years. We expect high-grade bond interest rates to remain low and perhaps go lower. The bond buyer index of high-grade general obligation tax-free bonds recently hit a new low yield.



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