Many years ago, I lived near the Culinary Institute of America, the alma mater of many of the world's most celebrated chefs. After years of classes, the students' final proving ground was cooking for the institute's public restaurants.
In the 1970s and 1980s, the institute's premier restaurant was the Escoffier Room. It was expensive. And if you wanted to dine there, you had to plan ahead. In many cases, reservations had to be made a year in advance.
Every night, students were expected to deliver culinary perfection. And for the unlucky student assigned to the souffle station, the pressure was immense.
In chef Anthony Bourdain's book "Kitchen Confidential," he tells how students prayed every night, hoping to avoid the assignment to make the puffy egg-based dish, which had a tendency to collapse if conditions weren't perfect. To add insult to injury, the domineering head chef would berate any student responsible for a fallen souffle, loud enough for all to hear.
The Federal Reserve is now standing in front of the economic equivalent of a souffle station.
The Fed is likely to maintain historically low short-term interest rates for some time. But based on comments made on May 22 by Chairman Ben Bernanke, the Fed is attempting to figure out the appropriate time to cut back on its program called quantitative easing. Under this program, the Fed has been buying long-term Treasurys and mortgage-backed securities in an effort to hold down long-term interest rates.
In the kitchen, souffles fail for primarily two reasons. If you open the oven door too early, the cool air will deflate a puffy souffle like a stuck balloon. If you whip the eggs too long, you can literally beat the rising energy out of them. In monetary policy, the same risks apply.
The Fed is afraid to stop its asset-buying program too soon, for fear it will start to deflate our slowly rising economy. But after years of quantitative easing, the Fed doesn't want the economy to become too dependent on easy money. For instance, financial institutions have been able to passively borrow money at super-low rates and invest it in high-yielding securities. The Fed wants a more energetic banking sector, one that is motivated to loan money to businesses so that they can expand and hire.
On June 18, the Fed started its much anticipated two-day monetary policy meeting.
On Wednesday, Bernanke held a briefing to try to convince the world that he is not going to open the oven door just yet. He did, however, try to hint to financial institutions that they need to prepare for a time when the Fed will no longer whip out easy money.
The Fed Could Get the Recipe Exactly Right, and Still Scare the Market
Securities markets understand the Federal Reserve's delicate predicament. No matter what Bernanke says at the briefing, investors may continue to wring their hands until they see proof that the Fed's souffle -- the economy -- can stand on its own.
Also, individual investors as well as financial institutions want to stay one step ahead of the Fed. So if Bernanke whispers about slowing quantitative easing, the market may hear it as a shout.
We could see a continued market overreaction in the aftermath of Bernanke's briefing. As a result, dividend-paying securities -- and especially fixed-income securities -- could feel the brunt of it. But much of this will be a short-term phenomenon, and I am in this for the long haul.
Over the last few months, I've pared back some of my portfolio's exposure to longer-duration fixed-income securities. I may continue to cull a few more positions over time if conditions warrant. I've also added some securities that I believe will do well in the road ahead, such as the insurance provider RLI (RLI) and semiconductor company Intel (INTC).
I've also kept my eyes open for new dividend-paying funds that have launched. Fund companies, after all, also want to stay one step ahead of the Federal Reserve. They are working hard right now to provide new products that are appropriate for current and future economic and market conditions -- and tempt income investors like you and me.
Action to Take --> In my upcoming issue of the The Daily Paycheck, I'll be profiling a brand new bond fund that offers a unique kind of interest rate protection. But most of all, I will do what I have always done. I will reinvest my dividends in solid securities with good track records for providing a stable and/or growing dividend stream. On days when the market dips, I'll have the opportunity to reinvest to purchase more shares at lower prices and higher yields. And every month, I'll have more shares generating even more dividends.
No matter what Bernanke says -- or how the markets parse his words -- his goal it to get to a highly functional economy. And in the end, that will benefit all securities.
The Culinary Institute's souffle station may have been stressful and hectic. But when I had the rare opportunity to dine at the Escoffier Room, I assure you -- my souffle was always perfect.
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