Has the U.S. Federal Reserve saved North America and perhaps the world?
The short answer is: sort of.
For a long time it has been conventional wisdom that Federal Reserve chairman Alan Greenspan is a “maestro”— the economy is in good hands. The defeat of inflation in the early 1980s is often attributed to his steady hand at the helm, but most observers forget that the ship had already started to right itself under his predecessor, Paul Volker.
This unprecedented economic expansion is also attributed, in large part, to Greenspan, but here again, it is likely overstating his role. The fall of the West’s mortal enemy, communism, and the advances in technology were entirely independent of his actions.
Now, don’t get me wrong, Greenspan has done an excellent job as chairman, and I would vote to have him stay, but I think it is important to note his true impact. What is more important is to know how stocks react to perceptions of the strength, or weakness, of the economy.
Why does one’s opinion of Greenspan matter? Because many investors are making long-term investment decisions based on the actions of the U.S. Fed.
There is an old saying on the street: “Don’t fight the Fed.” Meaning, when the Fed starts increasing interest rates, stocks generally do poorly and when the rates start to fall stocks do well. Specifically, falling rates imply that the economy is not doing well and, in the market’s predictive nature, has nowhere to go but up.
In general, sectors that do well when rates fall are financials, cyclicals and technology because they have the most to gain from a strengthening economy. If you have followed the market since the first Fed rate cut in early January, you will note that those sectors have out-performed others.
However, for those investors who want to buy individual stocks, it’s hard to know which ones to buy. A common mistake investors make in these situations is to buy technology or financial stocks that made them money in the last cycle.
More often than not, that is the wrong thing to do, especially in the technology sector. The technology sector makes its living on innovation and adaptation. Companies that were successful in the last cycle are likely much larger now than they were then, and may be less able to innovate and adapt to the new environment.
Investors are best served by investing in companies that are smaller and newer to the marketplace or did not participate as fully in the last cycle. This means staying away from the Intels, Federal Express and the Nortels, and buy the Open Texts, CNF Transportations and Gennum’s of the world.
If you have been reading this column for a while, you will notice a common theme. As the economy slows, investors must look for new, innovative, and generally smaller companies to invest in. In a slowing economy, Greenspan is doing the right thing to lower rates now, but his actions are not magical and won’t change basic economic realities.
The economy had a great run, and as a result there are many very successful companies out there. However, things have slowed down, and history tells us a new crop of companies will come to take the place of yesterday’s winners.
(Evan Spiropoulos is a portfolio manager of the Norrep Fund, a public small-cap fund managed by Hesperian Capital Management.)
