The Federal Open Market Committee (FOMC) concluded its two day meeting yesterday with their customary announcement at 2:15 PM.  The statement concluded (as everyone expected) that the Fed would leave rates unchanged at a target of 0% to 0.25%.  More importantly, the committee said that it plans to keep rates exceptionally low for the foreseeable future – a very popular stance with the masses, but one which could lead to significant trouble down the road.

Essentially, it looks like the committee is trying to have its cake and eat it too.  The official posture is that the economy is improving and capital markets are once again functioning.  To back up this assumption, the Fed points to improving consumer spending, and home buying activity.  Now those two areas have been artificially propped up by two major government programs…  The “cash for clunkers” measure, along with the first time homebuyers tax credit.

While these programs have been terribly inefficient and mismanaged, they did in fact push consumer spending into a positive trend.  The government has taken capital from current and future taxpayers, allocated it to encourage two specific types of transactions, and then used these transactions as “proof” that the economy is recovering.  Meanwhile, unemployment continues to increase, and an asset bubble has begun to inflate around risk related assets.

The Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability. ~FOMC Press Release

At the same time the Fed is stating verbally that the economic picture is improving, the posturing states that they are scared to death of the underlying economic situation.  Keep in mind that a zero to 0.25% interest rate is basically unprecedented in modern economic history.  The decision to cut rates to zero was born in the days of full-fledged panic when it looked as if our entire global financial system would fall apart.  Even a 1.5% or 2% fed-funds interest rate is considered “accommodative.”  But our rate structure implies that we are still at DEFCON 1.

Has the S&P Broken Final Support?

The difficult pill to swallow in this situation is that fiscally conservative individuals are being unfairly treated in an attempt to create more risk taking.  Interest rates on deposit accounts are at all time lows.  Retirees with more than a million in net worth cannot possibly live on the interest they receive on their capital.  Not unless they put that capital at risk in a shaky economic environment where they could easily lose a substantial portion of their nest egg.  It seems the government is content to offer incentives to encourage the very same risky behavior that got us into this mess in the first place.

A prominent money manager has been quoted (and this is admittedly a poor paraphrase) as saying that the tragedy of this recession is that we will emerge having learned absolutely nothing.  I fear that this may be true for our society in general, but does not have to be true for us individually as investors.  Some of the takeaways I have gleaned from the last 24 months include:

• Risk control is always paramount in any investment strategy
• Markets can be carried to unexpected extremes (both higher and lower)
• Lost opportunity is easier made up than lost capital
• Always understand the other side of the trade

We’ve got a ways to go before the economy and our markets are out of the woods.  If you have participated in the run up since March, count your blessings but make sure you have an exit strategy in place.  The markets gave up nearly all gains in the wake of the “positive” FOMC announcement which may be indicative of a sharply lower move in the next few weeks.

So keep your defense on the field and consider raising cash or initiating short positions.  There’s no reason to lose all of the gains from the last eight months.

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