In Fed We Trust?

We find it surprising that so many people trust what the Fed says about the economy. They have had a less than stellar track record at both predicting the recession and the severity of that recession, yet for some reason the markets continue to have faith in both their ability to forecast the economy AND control the direction of it.


Take a look at some of the comments former Federal Reserve Chairman Ben Bernanke made over the 2 years leading up to the financial crisis while leading the Fed.  SEM’s comments from October 2008 and a brief commentary on today’s market follows:


March 28, 2007 – DJIA = 12,300

“I would make a point, I think, which is important, which is there seems to be a sense that expansions die of old age, that after they reach a certain point, then they naturally begin to end. I don’t think the evidence really supports that. If we look at history, we see that the periods of expansions have varied considerably. Some have been quite long. At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.” 


May 17, 2007 – DJIA = 13,476

“We have spent a bit of time evaluating the financial implications of the subprime issues, tried to assess the magnitude of losses, and tried to determine how concentrated they are,” Mr. Bernanke said in response to a question following a speech here. “There is a sense that, although there is always a possibility for some kind of disruption … the financial system will absorb the losses from the subprime mortgage problems without serious problems.” 


July 18, 2007 – DJIA = 13,918

“Thus, declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time. For the most part, financial markets have remained supportive of economic growth.”


November 8, 2007 – DJIA = 13,266

“Incoming information on the performance of mortgage-related assets has intensified investors’ concerns about credit market developments and the implications of the downturn in the housing market for economic growth…… The spillover to the economy from housing still appears to be limited and it is the Fed’s hope that the housing market will find a bottom by next spring.”


January 11, 2008 – DJIA = 12,606

“The Federal Reserve is not currently forecasting a recession. We are forecasting slow growth.”


February 14, 2008 – DJIA = 12,376

“The outlook for the economy has worsened in recent months and the downside risks to growth have increased. To date, the largest economic effects of the financial turmoil appear to have been on the housing market, which, as you know, has deteriorated significantly over the past two years or so…..our economic forecast does not foresee a recession but a period of sluggish growth followed by a somewhat stronger pace of growth starting later this year as the impacts of the Fed’s rate cuts and the economic stimulus package of tax rebates begin to be felt.”


April 2, 2008 – DJIA = 12,608

“It now appears likely that real gross domestic product [GDP] will not grow much, if at all, over the first half of 2008 and could even contract slightly. We expect economic activity to strengthen in the second half of the year, in part as the result of stimulative monetary and fiscal policies. However, the uncertainty attending this forecast is quite high and the risks remain to the downside.”


June 9, 2008 – DJIA = 12,280

The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”


October 20, 2008 – DJIA = 9,265

“With the economy likely to be weak for several quarters, and with some risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate,”

[SEM’s COMMENTS, 10/31/2008] What the Fed does now will not really matter. Jobs are still being lost, houses are still being foreclosed, the types of creative financing that allowed the housing boom to begin will not be available, the government, businesses, and consumers will still be heavily leveraged, and consumer confidence will still be shaken. It may help the financial problems in the U.S., but this is a world-wide financial crisis.

The nice part about our management is we do not have to predict which way the economy goes. Our systems are designed to look at the intermediate-term trend. We have little exposure to the market at this time. As most of you know, we have a strong history of real-time experience navigating these types of markets. Because our systems are 100% mechanical, emotions are removed during tough times like this.

Our clients pay us so that we can watch their accounts daily, ready to make a move. Our number one priority is capital preservation and that is what we have been doing.

[SEM’s COMMENTS, 8/14/2016] With the benefit of hindsight we know a few things.  


1.) Even though the Fed was telling us in February 2008 & again in April, the economy entered a recession at the end of 2007


2.) Despite the Fed’s (and market’s) confidence the rate cuts & other stimulus plans from the Fed & Congress (remember those tax refund checks?) the economy continued to plummet at a rate much faster than anybody thought it could.


3.) Even after the Fed encouraged Congress to approve the largest stimulus package in the history of our country in October 2008, the Dow, which was down 25% already from the spring 2007 highs, fell an additional 29%.


4.) SEM’s programs weathered the storm quite well with losses significantly lower than the benchmarks, with some programs (Tactical Bond in particular) actually making money in 2008.


5.) Unfortunately, many of our clients did not benefit from our strong performance during this period as we lost 30% of our assets from the beginning of 2007 through the middle of 2008 as clients and advisors left SEM for investments that had higher recent performance & lower fees.


Sound familiar?  Like we saw in 2007, the environment is ripe for another Forest Fire.




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New Kent, VA
Jeff joined SEM in October 1998. Outside of SEM, Jeff is part of the worship team at LifePointe Christian Church where he plays the keyboard and bass guitar. He also coaches a club soccer team.