Frank Thoughts: The Past, The Present
Frank Boland
June 13, 2022

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?

The genesis of the first inflationary experience was the same as the current one. Governmental largesse. Sixty years ago, it was known as “Guns & Butter” (Viet Nam and Social Welfare). Today it is the trillions of dollars spent on debt and covid relief crises with a concomitant 12 years of 0% interest rates. This 0% was unique in 5,000 years of civilization. Printing more money to buy existing goods caused inflation both times. It may be hard to believe, but the Federal Reserve has over 400 PhDs in economics working for them. We know now why college catalogs list economics as a “social science.”  

The ensuing decades of the former bull market in fixed income would change the “face” of Wall Street. Unlike stocks, bonds had no central public exchange.  Instead, they were traded by phone. This gave complete secrecy to all transaction prices.  Moreover, the brokers could markup or markdown the price of the bond by as much as 5% as a “net” (no commission) trade. This changed the entire investment business model from a relationship business to a transactional business. Michael Milken of Drexel Burnham became the poster child of its abuse with his “junk” bond $550 million payday.

The length of the 40-year bull market cycle gave investors enormous confidence in the sanctity of investing in fixed income. Afterall, investors not only received unprecedented high rates of return but would make money as the market value of bonds would go up as interest rates continued to go down. For bond brokers, it was a nirvana experience. They could hide 5% in hidden commissions and the customer would still make money as the bull market lasted for decades. It was captured in Michael Lewis’s book, Liars Poker. A painful loss, due to rising interest rates, was an unimagined experience.

Subsequently Lehman Brothers and Bear Stearns would follow Drexel Burnham in the 2008-2009 debt crash. They were topped by Citi Bank which had 49 billion of Collateralized Debt Obligations (CDOs) off balance sheet. They did this so they did not have to show it as a liability while collecting interest payments from the debt. This hubris led to the collapse of Citi’s stock which declined from $50 down to $1 in the debt crisis. They then had to reverse split its stock 1 for 10! Today the stock – adjusting for the reverse split – is now $5 not the quoted $50. The bank did it to avoid delisting by the N.Y.S.E.

Such were the consequences of the extraordinary bull market in bonds. For stocks, the 17-year period of rising Fed funds was negative for large capitalization issues such as U.S. Steel, General Electric, and General Motors. They were mature companies of the industrial age and became “dead” money for years. Today, Apple, Amazon, Alphabet etc. are the “new” economy, but much as with their industrial predecessors, they are reaching the Law of Big Numbers. Investors need to find entrepreneurial stocks such as Walmart, Microsoft and Nike were in the past.  These companies earned money from the beginning even with the Federal Reserve raising interest rates on a secular basis!

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