Well, that didn’t take long. A couple of months ago, Ben Bernanke started the inevitable process of weaning the markets off his monetary methadone. He talked openly about the process of winding down quantitative easing, tapering bond purchases and eventually normalizing monetary policy – assuming the economy cooperated and sustained its feeble but forward momentum. Unfortunately, the markets threw a hissy fit and central bankers the world over were forced to react to Bernanke’s attempt at tough love. Emerging markets faced a double whammy of falling currencies and weak growth, a toxic mix that tends to spur inflation fears even as growth wanes. Some countries eased monetary policy to spur growth while others hiked rates to try and protect their currencies. China had a liquidity hiccup that for a while looked like a budding crisis. Mark Carney, the Bank of England’s new head, saw the need to reassure traders that a firming of policy wasn’t coming any time soon while Mario Draghi at the ECB promised low rates for a Fed-like “extended period”.

Then last week, faced with a market rate hike he obviously didn’t want or expect, Bernanke channeled Emily Litella and told the market never mind. Numerous Fed governors had spent weeks trying to backtrack Bernanke’s post-FOMC meeting press conference comments to little effect but it only took a few sentences from the new maestro and suddenly stocks were back to making new highs. Bond markets didn’t move as much but Bernanke’s soothing words did manage to knock about 12 basis points off the 10 year Treasury note yield. For future reference, one can probably just ignore everyone at the Fed except Bernanke; he alone has the power to move markets. So what exactly did Bernanke say that markets liked so much? Beats me. Whatever it was, it must have been in a dog whistle like frequency that only certain traders can hear because I sure didn’t hear anything new.

What happened last week based on a few words from Bernanke demonstrates the degree to which markets have become destabilized by the world’s central banks. Bernanke and his central banking cohorts appear to be attempting to control not only capital allocation within their own economies but capital flows around the world. Bernanke’s attempt at starting the normalization process produced global consequences that threatened what he sees as his good work to date. Rising US interest rates at a time of falling inflation expectations became a threat to the US housing market as mortgage applications started to fall. Meanwhile, a rising US dollar was wreaking havoc in China and other emerging markets that threatened to dent US multinationals corporate bottom line. Throw in fears of a renewal of the European debt crisis and Bernanke was forced to blink. Bernanke is reacting to markets as much as they are reacting to him.

It is probably not coincidence that Bernanke’s attempt to assuage market fears came just after similar moves by Mark Carney at the BOE and Mario Draghi at the ECB. Their comments last week added to the upward pressure on the US dollar, a move we know from the Fed meeting minutes is seen, along with rising interest rates, as inimical to US growth prospects. With Mario Draghi entering the currency wars in an attempt to revive German exports, a response from Bernanke to reverse the rise in the dollar was almost inevitable. Once upon a time, economic growth was thought to be created by things like efficient capital allocation and improvements to productivity. Today it seems central bankers believe it is entirely contingent on a weak currency that enables your country to steal limited global demand from your neighbors.

The problem with this view of the world is that consumption demand is not the driver of economic growth but rather the result. Global demand is not – or at least should not be – a fixed sum for which countries compete. Given stable money and a level playing field, human ingenuity on a global scale can produce and consume a limitless bounty of goods and services. In a world of limited credit it is more obvious than ever though that one must first produce in order to consume. In their defense, the developed world’s central banks are faced with a phalanx of politicians arrayed against enacting policies that would unleash this organic growth. The emphasis on bad austerity in Europe and the US means that Draghi and Bernanke (and a few other central bankers) are the last line of defense against a renewal of global recession – assuming their policies eventually work, which is far from assured.

The result of all this dependence on central banks – which has now been reduced to nothing more than central bank rhetoric – is economic instability. While it is often reflected as volatility in financial markets, it is the fragile nature of the global economy – the instability – that produces the bursts of volatility we’ve seen recently. A minor change in rhetoric at the Fed, possibly even unintentional, pushed global markets to the brink of a crisis that was only reversed by another change in rhetoric. God forbid Ben Bernanke get laryngitis or writers block. The instability of global economic growth and the possibility of a misspoken or misunderstood phrase from one of the world’s central bankers makes investing a more complicated and speculative activity than it has ever been.

At Alhambra we are navigating this world by reducing risk and maintaining larger cash balances than normal. Our performance so far this year, given our large cash balances, has been acceptable if not spectacular. Our global stock portfolio managed to beat its global benchmark by a fraction of a percent even while holding roughly 20% cash – and sometimes more – for most of the first half of the year. Our world allocation portfolio has performed in line with similar funds but with a slightly negative return in bonds it lagged the stock market by a significant margin. That is, however, the nature of a balanced approach these days. Prudence is not rewarded in a world where central banks are intent on forcing investors to take risk and interest rates are suppressed to the point of insignificance.

Until we reach a point where economic policy consists of something more than the rhetoric of central bankers, investment and trading success will continue to be more due to one’s linguistic skills than one’s ability to analyze fundamental factors. The Fed is operating on the theory that rhetoric – or forward guidance as it is known in the central bank lexicon – is sufficient to guide the economy toward sustained growth. Until that theory is either vindicated or proven false, we will be subjected to a continued cacophony of monetary gibberish.

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“Wealth preservation and accumulation through thoughtful investing.”

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@4kb.d43.myftpupload.com or   786-249-3773. You can also book an appointment using our contact form.