This year’s CFA Annual Conference, a gathering of leading investment professionals, is meeting in Frankfurt, Germany. Jason and I are in attendance representing Sherpa Investment Management and look forward to hearing about current investment trends and research.
The conference kicked off tonight with a session by Dr. John M. Coates. He talked about investors’ behavioral responses to volatility and risk. One of his main points was in regards to policy setting by central banks.
Beginning with former Fed chairman Alan Greenspan, and continuing with Ben Bernanke and Janet Yellen, the Fed began giving greater transparency as to monetary policy. Investors could read the Fed minutes and know whether the Fed intended to expand or contract money supply, and make investment decisions with that guidance in mind. This was done in an attempt to bring greater understanding and order to the investment markets.
Dr. Coates found that just the opposite has occurred. When Paul Volcker was Fed chair, he gave absolutely no guidance. When looking at the volatility in the stock market, there was a direct correlation between a risk in volatility and greater Fed transparency. Greater Fed transparency = greater volatility = greater risk taking investor behavior.
So what gives? Why did volatility increase? Dr. Coates says the reason is that investors viewed the Fed guidance as reducing risk in the market, and hence were more willing to take risk. This, in turn, increased trading volatility and is at least partially responsible for the huge market swings we witnessed in 2000/2001 and 2007/2008.
Perhaps in response to Dr. Coates’s findings, the Canadian central bank recently indicated that they will no longer provide policy guidance in an effort to bring lower volatility to the Canadian stock market.
This tells me that we should be on the lookout for unintended consequences of any policy or investment decision. While the Fed wishes to bring about stability, they ended up doing the exact opposite.