Fooled by Randomness

The equity and bond markets ended the first three months of 2019 with gains. The headlines attribute this to the Federal Reserve who, they say, said they will not raise interest rates in the near future. It’s not April Fool’s Day anymore, but this explanation is no more accurate than a bad joke.

I offer only one piece of evidence, but I could offer countless more recent examples. If you believe the Federal Reserve controls interest rates, please read the autobiography of one of the Fed’s most powerful chairmen in history, Paul Volcker (Triumph of Persistence). If there was ever a time when the Fed was active, it was during his tenure in the early 80’s. Interest rates on home mortgages were in the mid-teens. The Fed attempted to lower rates (twice) and rates rose instead. Then the Fed raised rates, and guess what happened?

We don’t need to get into the details of what the Fed does, what the Treasury does, and what the markets actually do. Instead, all we need to know is a little history. The truth is, the markets control interest rates. Not the Fed. Not the Treasury, nor the President, nor Congress, nor China or any other identifiable individual or force. No one controls interest rates. Be comfortable with this complexity.

No one can predict interest rates with any reliability. Unlike equities, or the economy for that matter, interest rates do not have a long-term trend either up nor down. Corporate wealth begets a growing economy. I believe interest rates are—largely—random, and their effects on equities are only temporary.

Here’s one example:

Equities often rise after rates are increased. The first three months of this year, however, the financial press gives credit to a potential rate decrease as a boost to equity prices.

The title of this Periscope is a heavy book written by a statistician and investment manager, Nassim Taleb. I don’t recommend you pick it up. I’ve quoted it for years. He’s been quoted for years. The book has been misquoted and misinterpreted more times than I can think of. Instead, keep the two truths in mind as you listen/watch/read investment commentary. Don’t be fooled by randomness. Rates are controlled by the market, and no one else. Rates are largely random and definitely unpredictable. And we can embrace and find comfort in this complexity.