The Fed Could Cause Market Disruption

In an article in last month’s Barron’s, Tocqueville Management Fund chairman John Hathaway shares his firm’s belief that “the Fed’s view of economic activity is not rooted in reality and that its stubborn pursuit of interest rate hikes is likely to precipitate a bear market in equities and bonds.”

Hathaway, senior portfolio manager of the Tocqueville Gold Fund, notes that strength in the financial markets is dampening investor interest in gold and adds that increased interest will be “closely related to financial-market damage of sufficient magnitude to shake prevalent investor complacency, best reflected in persistent record-low readings in volatility (VIX index).”

According to Hathaway, the current level of complacency is due to investor confidence in continuing economic expansion and a “pain-free” shift to a more normalized monetary policy and interest rate environment. He argues, however, that the two expectations are “incompatible and unattainable simultaneously.”

The resulting “vulnerability of asset values,” writes Hathaway, is exacerbated by stretched valuations, low volatility in the market and rapidly expanding sovereign debt in the U.S. (while “the rest of the world is a time bomb”).

Hathaway concludes: “We suspect that the Fed has already lost substantial credibility, but that investors prefer to look the other way as long as financial-asset values remain intact. It is, in our opinion, an ‘everybody knows the dice are loaded’ situation that could portend an even sharper, impossible-to-escape downdraft once confidence is dislodged.”