Don’t Fight the Fed (and Other Advice)

02/03/2012 11:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Instead of prognosticating, it’s usually smarter to stick with what you know, writes Richard Lehmann of Forbes/Lehmann Income Securities Investor.

If you are one of those investors who follows the daily musings of talking heads and invited gurus on the business channels, you know this is the season for two topics: the Republican presidential primaries, and the outlook for the securities markets for 2012.

As an investment advisor, I cannot avoid my responsibility to provide my two cents worth on at least the latter subject. I am hearing an unusually wide diversity of opinions, ranging from a market that will rise 25% or more, to a forecast of little or no net growth.

In evaluating these opinions, one must allow for the motivation of the prognosticator. The gurus will hedge their forecasts because they want to be invited back, so most will not stick their neck out with strongly bullish or bearish forecasts.

Others see a shot for fame and glory, so they throw a Hail Mary prediction…a la Meredith Whitney with her market disrupting and wildly erroneous prediction of massive defaults in 2011 for municipal bonds.

Many say stocks should go up because they are undervalued. It’s popular to say, and makes you feel righteous sticking with your stock portfolios. However, unlike dividend and interest payments, it’s hard to take to the bank, every month, like clockwork.

My approach is to first deal with what we know. We know that the Fed intends to keep short-term interest rates ridiculously low in the name of stimulating the economy, albeit the more likely reason is to subsidize the cost of funding the $15 trillion Federal debt at the expense of "the rich" (defined as anyone with enough investment capital to afford a subscription to this newsletter).

We also know that the Fed intends to meddle with long-term rates, keeping them artificially low in order to ease the adjustable-rate mortgage crisis and stimulate the housing market.

The third thing we know is that market volatility will be as high in 2012 as it was in 2011—this because of the instability in Europe, and because the high-velocity traders who dominate the stock market need volatility to make money in a flat market.

While there is a great deal of uncertainty in forecasting stock performance in 2012, the same is not true for income investing. We are being told by the Fed that it will keep interest rates low for all for 2012 and beyond.

One mantra accepted by almost all investment managers is “don’t fight the Fed.” In fact, why would you? They are telling you that if you buy securities yielding more than 2%, you will make money.

The major problem for income investors in 2012 is volatility, which is another way of saying timing your purchases. This can be an opportunity if you time purchases right, but it is not necessarily a huge negative if you don’t.

We know that today we can lock in 5% to 8% returns in fairly safe securities. By observing a few precautions, you can avoid major erosions of principal over time, while collecting a high cash return which is unaffected by the volatility. Such a formula has beaten the major stock indexes over the last ten years and is likely to continue to do so for years to come.

You won’t hear many of those guest gurus subscribing to my view, but then, how many years have they beaten the stock indexes, as have our model portfolios?

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