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Did We Just Get A Game Changer?

Fed Junk

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Just when you think you have a plan set in the game of life, someone changes the rules.

Today, the Federal Reserve announced that they were going to start buying Junk Bonds.  Yes, you read that right.  They are going to buy the bonds of companies whose ability to repay the debt is in doubt.  What does that mean for the Investment Strategy I outlined for you yesterday?  In short, A LOT.

You likely recall the graph above from yesterday’s post.  Yesterday’s graph showed that I assigned a 75% that the stock market has put in a low and that we would move up to the Relief Rally Recovery Zone, then move back down to test the low before we head back to new highs; a W shaped recovery..  I also showed that I assigned a 25% chance that the coming (or more correctly the current) recession would not be a short term cyclical event and instead turn into a longer term secular event, meaning it would be a longer time for the to return to previous highs; a U shaped recovery.

I have amended the graph to show a 70% chance of a W shaped recovery and a 15% chance of a U shaped recovery, but added a 15% chance of a V shaped recovery that does not test the lows.  The fact that the fed is putting a safety net under the weakest corporations means we anticipate fewer (maybe significantly fewer) corporate bankruptcies due to the recession, which lower the inherent economic risk that the recession cause a feedback loop of corporate bankruptcies that extends the recession for a longer period.  You will see that I have added some solid green arrows to represent a potential path for the market to new highs which could be reach sooner than in the W shaped recovery’s dashed arrows.

If the terms I am using seem foreign, the past three blog posts define them for you and if you are interested you can give them a read.  The investment strategy I outlined in yesterday’s blog post remains the same as I still anticipate that the W shaped recovery will be the reality, but the Fed’s buying junk bonds really is a game changer in terms of investment and credit risk.  The only thing I am curious about is whether we should be looking at adding a position in a high yield bond fund to our fixed income portfolios – they have been rising in price over the past week or so as many investors have been anticipating this (I honestly didn’t believe this would ever occur – I figured when the Fed stated two weeks ago that they would never buy junk bonds, they meant it, but that’s just the way it is).  This will take some pondering so no action is anticipated on it at this time as the easy money has been made.

 

–Mark