Swedroe: The Surprising Lessons Of QE

November 05, 2014

Ignore Forecasts

Hopefully, the lesson you take away from this discussion is that the winning strategy is to just ignore all such forecasts and adhere to your well-thought-out financial plan.

If you have trouble ignoring forecasters, it might help to remember this pertinent advice from Warren Buffett: “We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

He also provided investors with this warning, from Berkshire’s 2013 annual letter to shareholders: “Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous.”

What To Do Now?

The end of the Fed’s QE program does not mean bond investors are better off staying in cash or in very-short-term investments. Such a conclusion fails to consider that the current yield curve already reflects the expectation that interest rates are going to rise. Thus, for bond investors to actually lose money, interest rates must rise faster than already implied by the current yield curve.

The historical evidence demonstrates that efforts to outguess the bond market are highly unlikely to be productive. Standard & Poor’s twice-yearly Active Versus Passive (SPIVA) scorecard regularly demonstrates that active bond managers fail miserably — even worse than active stock managers —at beating their benchmarks.

That certainly has been the case for bond bears over the past half-decade. About six years ago, at the end of October 2008, the 10-year bond was yielding 4.0 percent.

The investors who followed the advice of forecasters calling for rising rates likely missed out on a large bond rally. They were stuck earning almost no return and have yet to be proven correct.

More History Lessons

If you’re still tempted to listen to the warnings of market “gurus,” consider the historical evidence from prior episodes of quantitative easing. In the 1990s, Sweden’s central bank, the Riksbank, more than doubled that country's monetary base during the Nordic banking crisis. Inflation there remained moderate both during and after the expansionary period.

Even as the monetary base jumped, from 1994 to late 1996, inflation did not follow suit. In fact, it remained flat before falling in 1996.

And Sweden was not an isolated case. The Federal Reserve Bank of St. Louis examined expansionary periods over the last two decades in the U.K., Switzerland, Japan, Australia, New Zealand and Iceland.

Fed researchers concluded that quantitative easing is a useful policy tool and that doubling or tripling a country's monetary base doesn’t lead to high inflation if the public views the increase as temporary and expects the central bank to maintain a low-inflation policy.



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