Thought of the Week

1. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
Thought for the Week (296):
The War Goes On
Synopsis
 The Investment Committee has been highly critical over the Fed’s decision to keep interest rates artificially low for the last several years, and we are not alone in our criticism.
 The Fed released the minutes from their most recent meeting this week, which caused equity markets to surge just seconds after the notes were distributed.
 Fed commentary pointing to the likelihood of an even longer period of low interest rates than investors had expected was the catalyst for such a strong rally. However, the war goes on.
The FOMC Meetings
The Federal Open Market Committee (FOMC) consists of twelve members including the seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and four of the remaining eleven Reserve Bank presidents.
The FOMC holds eight regularly scheduled meetings throughout the year. At these meetings, the Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.
After each meeting, the Fed publishes a summary statement, which attempts to justify their current policy. Most meetings are relatively uneventful, however, investors analyze even the smallest details of these reports in an attempt to gain any insight into the future of monetary policy.
The Fed Can’t Explain Themselves
The Fed has kept interest rates artificially low by buying an unprecedented amount of bonds on the open market. As the available supply of bonds dwindles as a result from the Fed’s buying, bond prices then rise, just as home prices rise when there is an increased demand for home ownership with little supply.
NOTE: Bond yields are inversely related to bond prices, so if bond prices are rising due to the Fed’s buying, then the yields on bonds are falling. Hence, the Fed can keep interest rates artificially low by controlling the supply of bonds available for investors to purchase.
One byproduct of the Fed’s massive shopping spree for bonds is that their balance sheet has exploded in size since 2009. The Fed is like any other bank, so they keep track of their assets and liabilities in a similar fashion, and every time they buy another bond, the balance sheet grows higher.
The Investment Committee remains highly critical of the Fed’s decision to keep interest rates near zero. Seniors and savers can no longer rely on government securities and other ultra-safe investments to generate needed income, and forcing them into riskier assets to pay their bills is unfortunate.
We are not alone in our criticism of the Fed. Deutsche Bank’s research group is one of the leading equity research teams on Wall Street, and they published the chart below back in February, comparing the size of the FOMC statement, measured in number of words written, to the size of the Fed’s balance sheet.

2. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
Source: Deutsche Bank Research
This chart is just one of the many examples of similar disapproval from seasoned investors. There’s a lot going on in this chart, and given that most of us are not experts in statistical analysis, let’s take a few minutes to explain the three most important takeaways:
1. Both are Rising: As the Fed’s balance sheet has risen since 2009, the number of words used to explain their actions in the FOMC monthly statement has moved in lockstep. Simply put, the more bonds that the Fed buys to keep interest rates artificially low, the more they feel the need to explain themselves to taxpayers.
2. Strong Fit: Statistical analysis commonly refers to a figure call the “R-squared”, which is a measure of how much the size of the Fed’s balance sheet explains the increase in the number of words in the FOMC monthly statement. This number is computed using complex algorithms by computers, and the higher the value indicates a stronger fit. A value of 0.88 is quite high.
3. Words are Expensive: Based on this relationship, Deutsche Bank computed that for every additional word in a future FOMC statement, the balance sheet will likely have risen by $6 billion per word!
NOTE: Ignore the “t-stat” and the line above this value. They are interesting to hard-core statisticians and the Investment Committee but do not add much to the conclusions derived from the analysis.
The bottom line is that the Fed apparently feels the need to offer the public more and more explanation as to why they continue to justify their war on seniors and savers. While we fully admit that this relationship could exist solely because the complexity of the Fed’s bond buying program requires a deeper explanation, we still feel that artificially low rates will not solve the problems in our economy.
Implications for Investors
The minutes from the most recent FOMC meeting were released on Wednesday and caused an immediate surge in equity prices because the Fed made it crystal clear that they have absolutely no

3. This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers
at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no
indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private
Capital is an SEC Registered Investment Adviser.
intention of raising interest rates to more normalized level anytime this year or next. Therefore, this war on seniors and savers will likely continue much longer than most investors had anticipated.
The unfortunate reality is that although we strongly disagree with Quantitative Easing (QE) and the rationale for the continued bond buying that has kept interest rates near zero for years now, we have no control over the Fed. The only option for investors is to accept the monetary policy and search for ways to profit with the investment tools available to us.
The bottom line is that finding attractive risk-adjusted income will continue to require active management from skilled professionals through 2016 at the earliest. During this time period, investors seeking income will be forced to choose between (1) short-term volatility in dividend paying equities, or (2) next to no income, interest rate risk, and inflation risk looming in many government and corporate bonds.
The key to profiting in these turbulent times is to maintain a long-term investment horizon and remember that volatility is not always bad. We expect to see more market swings in the months to come as we creep closer towards the midterm elections. Political uncertainty may cause stocks to sell off, and if it does, we will be ready to put our large cash position to work buying stocks that are hit for reasons driven by fear and panic rather than company fundamentals.