Rational Blog

Does the dog wag the tail or does the tail wag the dog?

I'm not so sure anymore.

The emergency action of the Federal Reserve is welcome relief from the carnage of a collapsing economy, but its timing shakes my confidence in this venerable institution.

I've been a Federal Reserve fan for a long time. Despite what you may hear from other pundits criticizing its actions, I feel quite strongly that the central bank has done a fabulous job of stewardship over the last 30 years or more.

Those blaming Greenspan for the housing bubble and ATM aspects of easy credit fail to properly assign blame to Wall Street, banks and borrowers. In addition, lower rates in the early part of the millennium staved off a deflation that would have lasted for many years.

We will never be able to prove such a belief because doing so would require us to change history, but I am quite certain bold action then prevented something far more scurrilous than a wee bit of inflation.

Flash forward to today and the new leadership of the central bank has me worried. Chairman Bernanke and his wish for transparency and consensus may be the wrong mix for the current situation we find ourselves in.

The recent cut in rates may have been the right move, but one has to wonder how they missed the boat in December when its actions were more timid and its statement continued to show much worry over inflation.

It is all a bit too wishy-washy for me at a time when bold leadership was needed to guide us through this morass. Did the Federal Reserve simply act to appease Wall Street preventing a correction that may indeed be quite necessary?

I think so and as a result the central bank thus loses one of its key tools, confidence, in its mission to achieve stable prices. So far the results have been favorable, but I do think caution should be used in our approach to the market.

No matter what the Federal Reserve does or does not do, I am a believer in the U.S. economy. That includes a strong belief in the value of the U.S. dollar and a suspicion over the supposed booming world economy.

To me the world is still heavily tied and levered to the U.S. If you figure the world is about six months behind the U.S. then world markets should lag the U.S.

In my Marketocracy portfolio I will act accordingly. That means building primarily long positions in domestic equities, done slowly over time, and selling global markets.

I'll start with a purchase of the ProShares Ultrashort China (FXP), Ultrashort Emerging Markets (EEV) and Short EAFE (EFZ) funds. I want to sell basic materials with a purchase of Ultrashort Basic Materials (SMN). I'll take $25,000 positions in each.

I also want to be long the dollar here and I will do so with the Rydex Strengthening Dollar x2 (RYSBX). I'll take a $100,000 position.

As for stocks I will start with a purchase of I-Shares Russell 2000 ETF (IWM). I'll take a $100,000 position here. Small cap stocks have been pummeled of late and to the extent the U.S. rallies, small caps should outperform.

Next week I'll start using the rest of my cash to take positions in long stories that I believe are undervalued. I'll be dollar cost averaging with monthly purchases over the next 6 months.

Jamie Dlugosch
The Rational Investor

Comments: View Comments |  Thursday January 24, 2008  |  Stocks: EEV, EFZ, FXP, IWM, SMN,