Do you want to know what is going on with the markets? It’s common sense duh.
At times, doctors, politicians, professors, and economists make things sound complicated when there are obvious logical answers. My guess is that they need to feel superior because, well, you know…The Fed and many well-known economists are looking too deep into the woods to explain why all the support, stimulus, and government spending were not going to have a major impact on either the economy or inflation.
They missed a giant red flag last year! 🚩
Who could have imagined that sending money to everyone’s mailbox through the American Rescue Plan Act (mailbox money), while Covid was causing supply chain shortages would create a condition we all learned in basic econ of “too much money chasing too few goods”? This condition is known to create INFLATION! With no formal plan to absorb this excess money and rates near zero, money found its way into the speculative markets. To add fuel to the fire, the government decided to embark on a giant infrastructure spending bill.
To be clear, I am not opposed to the bill per se, I am just surprised it wouldn’t come with a plan to dampen its obvious inflationary impact. That said, because of the excess money, investors were paid to take risks because returns and dividends on stocks were higher than the cost of borrowing money (i.e., fixed income rates). So, those who were not using the “mailbox money” for milk and diapers used it to speculate on the NASDAQ, S&P, crypto, real estate, and anything else with a yield above zero. It should have been obvious that once rates went up, assets would decline. The 2-yr treasury rate went above the dividend rate, and the market didn’t like that very much.
To focus on what the definition of transitory means is much like trying to define what the definition of “it” is. Transitory as consumers see it is different from the way investors or the Federal Reserve see it. When using the word “transitory” in economics, it means that if something had been doubling but now only goes up by 20%, the move was transitory. This is because the rate of increase didn’t continue at the same rate. For consumers, it means if the price of something goes up too fast, it is transitory until it comes down. However, not everything that goes up comes back down to the same level since some things are inelastic to the downside. Luckily, wages are one of those things that are very inelastic to the downside…or is that lucky for everyone? 🍀
Wages are one of the largest expenses for manufacturing companies along with interest rates. Last December, the Fed admitted that the recent price increases were not transitory like they first said and that they were going to hike rates to help lower inflation and energy prices (if they could). That statement put them in a position to hike rates no matter what, and not deviate as they did so many times in the past.
To stop rampant inflation unemployment will have to go up… a lot… and higher rates will have a negative impact on the markets. Once upon a time, a recession was defined as two negative quarters to GDP, which we had this year. A more modern definition includes slowdowns across many data points like employment and overall economic activity. I can’t recall a time in the past several decades where we were debating if we were in (or headed into) a recession while the Fed continued to hike rates. Every time we had even a whiff of a recession, the Fed would cut rates, bonds would stabilize, and stocks would rally. It was a nice and easy playbook…
This time we can’t use the same playbook…We used that play to heal the economic symptoms from COVID. The problems are also different. We changed the relationships of how the economy interacts. So far, here is the math: The Fed has hiked rates by 2.25%, short-term rates have tripled, and unemployment is still below 4% while inflation remains high -well above 8% for the last 12 months. Even if only 50% of this rate is sustainable, rates will need to double again. While unemployment is below 4%, the math suggests we can handle it.
Rates need to go higher, and the Fed is telling us that. In fact, they are more than telling us that – they are raising rates and tapering assets (the proverbial “voting with their feet”). If rates have more than doubled and wages are up ~10% year over year wouldn’t lower stock prices seem logical? It does to me. Astor’s proprietary index, Astor Economic Index® (AEI) thinks so too. We have followed this logic and data-based evidence and reduced exposure in all of our portfolios to the lowest levels since 2008. Hmmm…
To conclude, we have had the greatest inflationary spike since early 1980, along with the largest stimulus and relief packages ever. It only makes sense that we would have the largest response to this ever, but I have not seen this infamous bazooka I have heard so much about, and when that thing comes out, the recession will follow in a short course… Stay tuned.
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