So the Federal Reserve Doesn’t Care About the Stock Market? Baloney

The stock market is not—repeat, is not—part of the Federal Reserve’s mandate. But maybe that is changing, if not in the Fed’s official mission statement, at least in practice.

That’s the conclusion of Michael Arone, chief investment strategist for State Street Global Advisors US Intermediary Business Group. Now, employment and inflation are the official concerns of the Fed. The central bank’s policymaking arm, the Federal Open Market Committee (FOMC), never cites market movements in its decisions.

The stock market, though, is a part of the economic system, and Arone finds the Fed’s pooh-poohing of market reactions absurd. “FOMC members always dance around the role capital markets play in their monetary policy decisions,” he wrote in a recent research paper. “But it’s time they come clean.”

After the July 31 move to lower short-term interest rates for the first time in a decade, albeit by just a quarter-point, Fed Chairman Jerome Powell cited the US-China trade war and slowdown in Europe and China as concerns that merited an “insurance” cut. That sentiment was reinforced by the FOMC’s minutes from its last meeting, which were released Wednesday.

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That explanation for the rate reduction prompted Arone to wonder: “Why should any of these global concerns matter if employment and inflation in the US are the Fed’s only mandates?”

Sure, only a small sliver of the population owns stocks. The top tenth of the population by wealth has 84% of the stocks. Yet Arone pointed out that, thanks to retirement plans likes 401(k)s, about half of US households are in the market. And while stocks amounted to less than half of gross domestic product in 1980, they now are valued at $30.5 trillion (as of the start of 2019) and that’s 150% of GDP.

The market’s loss of $2 trillion in late 2008, amounting to a halving its value, sent consumer confidence plunging, and stocks took nine years to regain their pre-crisis level. Previous, less precipitous market declines “barely budged” the confidence index, Arone wrote.

“Equity levels impact valuations and cost of capital, and influence corporate hiring and spending decisions,” Arone maintained. So the next time you hear a Fed justification for its actions, you likely will see a third mandate, the market, between the lines.

Hey, Maybe the Fed Should Cut Interest Rates

Blame the Computers for Last Week’s Market Wipeout

Tags: Federal Reserve, GDP, Jerome Powell, Michael Arone, State Street, Stock Market

The nation’s largest pension fund finally implemented a long-coming plan, setting up a trust fund that allows public employers to prefund their pension liabilities. The fund provides a vehicle for investments designed to accumulate assets over time to mitigate employers’ difficulty with managing long-term costs and fees.

Called the California Employers’ Pension Prefunding Trust (CEPPT), the new fund “gives public agencies an opportunity to save and plan ahead,” said California Employees Retirement System, (CalPERS) Chief Executive Officer Marcie Frost. “Prefunding is a smart and efficient approach for employers to mitigate risk increases and temper contribution volatility. Benefits are only as secure as our employers’ ability to pay them.”

The asset allocation of the trust’s portfolio is designed with a focus on the relatively short timeframes that participants will remain in the trust, putting an emphasis on a portfolio strategy for short- and medium-term investments.

The board reviewed potential asset allocations for the two diversified strategies in June. Five separate portfolios were considered, and the two selected allocations and an explanation of the reasoning behind these selections is detailed in the chart below:

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Source: CalPERS

“A conservative portfolio is recommended for the trust portfolio 2, to accommodate a shorter investment horizon and lower risk tolerance,” Alison Li, investment manager, Trust Level Portfolio Management at CalPERS, said at the June meeting. “Staff propose portfolio 4 over portfolio 3, because portfolio 3 doesn’t offer enough difference from portfolio 2, and is also preferred to P5 because P5 has high volatility, which is not advised for investors with low to medium investment horizons and low to medium risk tolerance.”

The selected allocations also provide low investment management fees, with an annual fee of 0.25%, as well as improved financial security for active employees and retirees.

“We are excited to partner with local agencies and give them a tool they requested,” said Michael Cohen, CalPERS’s chief financial officer. “The trust will help local agencies reduce future obligations, reduce risk on their balance sheets, and address their future costs.”

The retirement system recently announced investments in its home state grew 11.6% in the 2017-2018 fiscal year.

CalPERS In-State Investment Program is Up More than 11%

Tags: Asset Allocation, California Employers’ Pension Prefunding Trust, CalPERS, Marcie Frost, Pension

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