Central Banks Dominate the Investment World

Rodney Johnson | Thursday, October 4, 2012 >>

You’ve no doubt heard it before… someone saying, “But this time it’s different.”

Ha. That’s a great quote… but only because it’s usually wrong.

The investment world was NOT different during the Internrnet bubble.

The world was NOT different during the housing bubble.

The world was NOT different during the great moderation identified by then Fed Chairman Greenspan.

But today, it really is different. What makes it so is the sole reliance that financial markets around the world have on central banks.

These central banks are not allowing the extreme debt bubble that swept the world over the past 25 years to burst as it normally would. Instead, they’re taking extraordinary action and causing severe market dislocations along the way.

As an example, look at interest rates…

On what planet does it make sense to have the “cost of money,” (short term interest rates) at zero when inflation is running 1.7%?

Why are investors gifting money to governrnments by purchasing 2- and 3-year bonds for negative interest rates?

Let’s face it, things are weird.


Right now central banks dominate the investment world.

The thing is, they have more capital than anyone else… because they can make more capital whenever they want.

And they don’t deploy their resources looking for yield. They’re not interested in growth.

Their goals revolve around stability. Central banks have completely different reasons for buying and selling securities than everyone else.

Unfortunately, markets have little experience measuring the success or failure of such actions and certainly almost no experience figuring out what happens as all this liquidity floods the planet.

This is a new situation we face. So yeah, this time is definitely different… which brings me back to the pitfalls and opportunities we’ve been looking at all week.

Pitfall: Ignoring Context

The advent of home computing has allowed anyone with passing knowledge of spreadsheets and access to online data to develop an investment system. These can range from the simple – like the golden cross that occurs when a stock’s 50-day moving average crosses above its 200-day moving average – to the complex, where daily momentum gains of exponential average returnrns are plotted against each other in a relative strength measurement.

This analysis is useful because investors get to see historical movements and trends. More often than not, what’s happening is no different than a similar situation in the past.

That’s why all such approaches have one thing in common: they rely on the relationships of yesterday holding true today.

Think about that for a minute.

Each systemic approach must rely on the idea that however price movements, PE ratios and interest rates worked together in the past, they are working that same way today.

These are typically referred to as black boxes, meaning investment algorithms and formulas that are kept secret.

And until four years ago, such black boxes could be useful if used appropriately.

But if the world has a new set of dominant investors that care nothing for such things, then how will the black boxes perform today?

Good question. One I’m not willing to bet my assets on to figure out.

Opportunity: Acknowledge the Newcomers and their Effect on Markets

A better way to approach the investment world today is to acknowledge the newcomers, like central banks… and to always keep context at the forefront of your investment strategies.

It’s like going to the same livestock auction every week and knowing all the other bidders there as well, and then one day a new bidder shows up.

The new guy has unlimited cash and doesn’t seem to care about the quality of the stock up for bid. The only questions are, “Will he bid today?” and “How much will he buy?” These two observations then work their way into the bidding strategy of every other person at the auction.

It must be so.

Our job as investors is to understand that relationships held in the past may or may not hold today because the landscape has changed.

This makes all of us reactionary investors, living and investing at the whims of central banks around the world.

It’s not pleasant. It’s not our choice. But it’s where we are.

This means that investors must remain vigilant in keeping up with the actions of central banks and parsing out what the course means for the markets, so that they don’t get run over by relying on a historical relationship when the world around them has changed.

Bringing it All Together

Over the past three days I’ve pointed out a number of pitfalls and opportunities in the current financial markets. If you’ve read them all, you’ve no doubt noticed a common thread…


For most of my childhood there was a product pitchman on TV named Ron Popeil. One of his products was a rotisserie oven and to demonstrate it he would prep a dish, put it in the oven and say, “Just set it and forget it!”

This is how many people approach investing and they run the risk of being ruined by it.

Today’s investment environment is fragile. The capital markets live from one central-bank-handout to the next. There is no clear path forward for how this works out.

In this environment investors must stay on top of the changes around them. They must move with the markets instead of sticking to any one discipline that “worked in the past.” And they must use a hedging strategy to protect against loss.

It’s hard work, but it’s also your money.

Believe me, it’s worth it.


P.S. Recently, Bloomberg Radio aired an interview with Harry and John Mauldin, Chairman of Mauldin Economics and Editor of Yield Shark, in which they discuss the future of real estate (among other things). You can listen to this interview here.

Ahead of the Curve with Adam O’Dell

Post QE3 Announcement

While central banks are distorting the current market, there’s no easy solution in simply following the Fed.

Rodney Johnson

Rodney’s investment focus tends to be geared towards trends that have great disruptive potential but are only beginning to catch on to main-stream adapters. Trends that are likely to experience tipping points in the next 5 years. His work with Harry Dent – studying how people spend their money as they go through predictable stages of life and how that spending drives our economy – helps he and his subscribers to invest successfully in any market.