There is an old saw on Wall Street that says “Don’t fight the Fed.”  Which means, in short, if the Fed is reducing nominal interest rates it is your interest to invest in stocks, and vice versa.  The question is by what means does Fed policy affect investor decisions.  Simple, through changing the relative return on stocks, bonds and cash.  This is easily illustrated through a chart of the yield on three-month Treasury bills, a proxy for the return on cash.  The sustained low interest rates have pushed investors, wittingly or not, out of money market funds into longer duration assets like bonds and stocks.  The Fed, of course, cannot push the economy around like it can short-term interest rates.  So there is always the risk that this aphorism could backfire.  However by altering market signals the Fed can have a profound effect on how investors see the relative attraction of various asset classes.  In today’s screencast we show how “don’t fight the Fed” works in action.

Items mentioned in the above screencast:

Monthly chart of three-month Treasury bill rates.  (StockCharts)

Is all the “cash on the sidelines” already committed to the market?  (VIX and More)

October AAII Asset Allocation survey.  (Charles Rotblut)

Investors holding least amount of cash since April 2000.  (Charles Rotblut)

Further reductions in cash may not be available to drive stocks higher.  (Money Game)

The logical consequence of 0% yields.  (Abnormal Returns)