Frank Boland's blog

“The Road to Hell is Paved with Good Intentions.” Such is the old (1828) Portuguese proverb. It would seem to be a reasonable description of the Federal Reserve’s prior policy for 12 years with interest rates at 0%. Ironically, there are also 12 Federal Reserve Governors on the Federal Reserve Board. These board members have more than 400 Ph.D. economists giving them their “expert” advice.

Mansions result from great partnerships. It was a lesson I first learned as a 12-year-old caddy. I would always ask the person I caddied for what he did for a living. To me, he was rich, and I also wanted to grow up and be rich. However, my father had inculcated me in the belief, that if I wanted to succeed, it would be solely up to me. His father had been killed in World War I, and his mother moved from Canada to Boston. He was placed in an orphanage while his three sisters stayed in a convent in Nova Scotia. His mother went to work as a housekeeper.

Price distortion in the stock market started in 2005 with the impact of high-frequency-trading. Three years later the Fed responded to the debt crisis with 0% interest rates. Both events would lay the groundwork for price distortion. Zero percent would obliterate active stock managers and give rise to trillions in index funds. The zero-interest rate policy set up what was to become a negative feedback loop. Over half the stock market became indexed which effectively removed it from the process of individual price discovery.

As I pulled into the parking lot of Pier 4 on the Boston harbor, I was stunned by what I saw. To my right were two colossal ocean liners, each about 1,000 feet long. The ships had large flags reading, “Welcome to DEC World.” It was 1987 and Digital Equipment was then a 14-billion-dollar computer company, second in size only to IBM. The ships had been hired to be used as hotels because every hotel in Boston was full; over 42,000 people had arrived in the city that week as “DEC World” guests.

Since 1956 there have been 10 bear market cycles when the market declined 20% or more. The first one led to the ensuing 1957 bull market that would give birth to the modern investment business. It also pioneered a new sector, then called electronics, now known as technology. In 1958, Jerry Tsai was chosen to manage the new Fidelity Capital Fund. Roland Grimm – the Fidelity Trend Fund manager – would tell me years later, “We had just 25 million under management and lost money every day we were open.” But that new bull market changed the investment business forever.

It is always after a stock’s decline that one discovers the reason it had previously been going down. The more parabolic (straight-up) a stock’s previous assent has been, the greater the need for a sell discipline. If you’re an investor on your own, or are looking to hire a portfolio manager, you or they must have a SELL discipline. We certainly know this from the extent of declines occurring in the current bear market. The average stock is down 30%!  Percentage declines of 50%-90% are common.

The last time the Federal Reserve was faced with raising interest rates - on a secular basis - was almost 60 years ago. Of course, no one could have imagined, three generations later, it would happen again. Both times it was thought to be a cyclical or “transitory experience.” In 1965 Fed funds were 1% on a 17-year journey to 20%! This resulted in the stock market going through several cyclical bull and bear markets going nowhere until 1982. Current Fed chairman Jerome Powell was 12 years old when it started. This time Fed Funds were lower at .0% on the way to … and for how long?

When a phrase of two words becomes famous, it’s not only apt to be truthful but powerfully accurate.  “Creative destruction” was first articulated by Austrian economist Joseph Schumpter in 1942. He used the phrase to describe capitalism.  It meant any innovation in the manufacturing process which increased productivity. Schumpter intended the phrase to describe what he called, “the essential fact about capitalism.” To him it was the crucial reality of how capitalist economies evolve and grow.

Those who are born mathematically “gifted” often develop an elitist attitude. Society reinforces that with movies such as “A Brilliant Mind” (John Nash) and “The Theory of Everything” (Stephen Hawkins). M.I.T. Professor Paul Samuelson personified this cultural mindset when he said, “When the worst economics grad student leaves M.I.T. and goes to Harvard, both of the departments’ averages go up.” As you may know, Samuelson taught in the 20^th century at a time when economics was heavily mathematical winning the Nobel Prize in economics in 1970.

In the last century, one could walk into a building and see plant and equipment. That’s not possible in today’s knowledge/service-based economy. Assets are “soft,” even invisible. The result is that we are forced to trust the validity of published numbers. However, given the deceptions that occurred with Enron and WorldCom, we know it is risky. It’s often revealed in bear markets. Computer Sciences was the first software fraud to be charged with a false statement of profits (2.8B) in 2006. The next major fraud will once again be in software.