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Soaring Stocks Break the Sacred Investing Rules

IWhat if you are If you were one of the many buyers of U.S. stocks or Treasuries over the past four months, or indeed the majority of financial assets during that period, this column has a message for you: Congratulations. Not only do you get a pretty solid return— Second&p The Big US 500 is up 15% – but you’re breaking a cardinal rule of Wall Street by doing so.

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The phrase “don’t fight the Fed” is associated with Martin Zweig, an American investor known for predicting the 1987 crash. Zweig’s logic is simple. Falling rates are good for stocks; rising rates are not. But the phrase’s scope has expanded over time. Zweig’s dictum is now used to suggest that it is never wise to go up against an institution that prints money and employs thousands of economists.

Most of the time, it is. In the past four months, however, the Fed has raised interest rates three times and markets have soared. On Feb. 7, days after a blast of labor market data, Federal Reserve Chairman Jerome Powell warned that the battle against inflation would take longer than investors expected. His warnings had little effect. Investors elsewhere also ignored the central banker’s words. Bank of Japan (Bank of Japan) has long pledged to stick to its “yield curve control” policy, but traders betting it would loosen policy won a big win in December when officials unexpectedly capped the yield on 10-year government bonds from 0.25 % raised to 0.5%.

There are good reasons to spar with central banks from time to time.Analysts at wealth management firm Truist Advisory Services reviewed records going back to 1954 and found that Second&p In fact, in many cases where the Fed hikes rates, the 500 does well, or even well. In fact, the index rose an average of 9% a year between the bank’s first and last rate hike.

Traders largely followed the Fed’s analysis because they believed it was based on better information. An influential study published in 2000 by two economists, Christina and David Romer, seemed to confirm that central banks’ forecasts were more accurate than those of their commercial rivals. But subsequent studies have yielded mixed results. One, published in 2021 by researchers at the Barcelona School of Economics and the Federal Reserve Bank of San Francisco, suggests that the strength of Fed forecasts has waned since the mid-2000s. Meanwhile, forecasts from other central banks were bad enough to invite mild sarcasm. The Riksbank has forecast interest rates to climb every year since 2011, only to end up cutting them. The resulting pattern, which shows forecasts rising over and over again like spikes, has been likened to a hedgehog.

In addition, petty fighting among central banks is also good for the wider financial system. Unless central banks want to directly control market interest rates by buying large amounts of assets, policymakers sometimes have to engage in so-called overt operations. Central bankers’ views on economic conditions and how they might affect interest rates have been expressed in speeches and written guidance, signaling optimism or pessimism on topics ranging from the economy’s long-term growth potential to financial stability. Done well, this communication can eliminate the need for rate changes.

In order to refine their guidance, though, central bankers need people to take a seat in financial markets so they can react to it. After all, as another Wall Street tenet states: differences make markets. Buyers need sellers, and information about investor expectations in general is revealed through market prices. Tossing back and forth between the government and the market is better than being forced into a corner by the government. Bank of Japan There has been a push to use bulk purchases to defend the bank’s credibility.

Traders are still often turned into mincemeat when taking on central banks. It’s one thing to be short the Fed when policymakers say they’ll be led by the data as they are now, and quite another when they’re all in. A December bet on a sudden rise in Japanese bond yields worked well for several risk-taking funds, but the trade was dubbed the “widowmaker” for a reason. In moderation, however, some tension between markets and central banks has value for both investors and officials. Even financial rules are made to be broken.

Learn more from our financial markets columnist Buttonwood:
The Last Breath of the Meme Era (February 2)
When Professional Stock Pickers Beat the Algorithms (January 26)
The $300 Billion Problem with Venture Capital (January 18)

For more expert analysis of breaking economic, financial and market news, sign up for Money Talks, our subscriber-only weekly newsletter.

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