Published Nov 11, 2022

This year has been difficult for all asset classes, especially equity securities. After a bad start, the stock market worsened through the summer, reaching new lows and panic among some market participants. A washout would have been good for the market, wiping out remaining excesses, but the market fell just short, despite striking a new low for the year.

Then came October, which is normally a not-so-good month for the market. It got a boost with the best October in years. Those who quit the market before October missed a big uptick. Volatility continued, with the market experiencing wide swings – some days by as many as 1,000 points in a trading day.

What is the cause of all the volatility? Inflation. Federal Reserve Chairman Jerome Powell and the board governors are intent on breaking inflation. They have made their intention clear, which has spooked the markets. Because of their continued, aggressive interest rate increases, we are likely to experience a recession.

The Fed is striving for a “soft landing” – i.e., no recession, but rather a cooling-off of demand. On the current path, a hard landing is likely. The market does not like the possibility of a hard landing, and so it fluctuates widely as it tries to parse each likely alternative.

The economy appears to be strong – too strong for the Fed. In the recent jobs report, employers added 261,000 positions in October, many more than forecast. While that may appear to be good news for some, it is not good news for a Fed that wants to see the economy slowing. In a bad-news scenario, the Fed took comfort in an uptick […]

Published Oct 7, 2022

Investors have a plethora of concerns in the current market. In the forefront is the Federal Reserve’s worry about inflation. For years, the Fed has targeted an annual rate of inflation of about 2 percent for the U.S. economy. Sure, shocks to the economy came and went, but the Fed was largely able to keep inflation in this 2 percent range. However, last year, inflation began to significantly affect most market sectors.

Initially, the Fed dismissed the increase, saying the higher inflation rate was just transitory and related to COVID shutdowns and supply chain issues in the manufacturing and service sectors. It was supposedly a one-off situation that soon would resolve itself. Officials chose to look the other way regarding the impact that their zero real interest rate policy and the government stimulus payments were having on the demand side of inflation.

One of the problems with inflation is that it feeds on itself, so as the rate of inflation began to compound rather than correct itself, the Fed belatedly recognized this and grew alarmed. The Fed and other central banks around the world began to clamp down on inflation by raising interest rates to cool the demand side in their economies.

Interest rate increases were not received well by the markets. Higher interest rates mean not only less economic activity, but increasing costs to debtors across the global economy, including the U.S. and other governments that dramatically increased their debt to keep their economies afloat. While more resilient than many, the U.S. economy began to chase its own tail. Inflation began to feed on itself.

The Fed became even more alarmed, realizing it had supported […]

Published Sep 9, 2022

After a strong, early-summer rally in the stock market, August saw a sharp drop. Now, at the start of September, which is historically the worst month of the year for equities, we must pause and reflect on the market direction.

Despite high inflation, the Ukrainian war, and supply bottlenecks, the economy has remained stronger than expected. The rally was supported by some good news: Profits have been better than expected. The jobs market remained robust in July. The total number of U.S. job openings was set to remain historically high, according to the Labor Department. The Conference Board’s Consumer Confidence Index climbed to 97.4 in August. The U.S. Manufacturing Purchasing Managers’ Index remained flat, with construction spending down slightly. The U.S. unemployment rate is expected to remain at a 50-year low of 3.5 percent. The price of gas at the pump fell roughly 40 cents from the prior month, according to GasBuddy. These factors and others made the case for the bulls.

The bears’ case was more direct: The Federal Reserve has taken a strong stand against inflation. Chairman Jerome Powell has made various statements about the evils of inflation and the unacceptably high level of inflation. Up until August, his pronouncements had little impact. Then, at the annual Economic Policy Symposium in Jackson Hole, Wyoming, Powell made a much stronger statement about inflation. He forecast a Fed policy determined to beat inflation. He said that households and businesses would suffer from higher interest rates and was undeterred by that prospect. No longer did he see inflation as “transitory.”

Powell demonstrated that he was willing to raise interest rates high enough to break the upward […]

Published Aug 5, 2022

In the second quarter of this year market sentiment soured, leading to steep declines in nearly all asset classes. This was driven by central banks throughout the globe attempting to corral inflation. Global equities declined 15.7 percent.

Powered by earnings, equity markets surged in July even though the Federal Reserve raised interest rates by 0.75 basis points for two consecutive months. Are we in a bear market rally, or something more sustainable? The S&P was up 9.1 percent for the month, but still down 13 percent year to date. The market gained support from three factors: comments by Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen that the economy is not in a recession, weaker jobs growth in July than in June, and strong corporate earnings reports.

The labor market remains tight. According to Dow Jones, 250,000 jobs were added in July, but that bullish indicator was countered by the fact that more jobs – 372,000 – were created in the prior month of June. This indicator of a slowing economy was taken as a good sign, because it shows that the Fed is achieving its goal of slowing the economy. A slowing economy might mean less aggressive rate increases. If rate increases are slowing, it might mean a shorter or shallower recession, because the Fed will have to pivot to smaller rate increases or none at all. These are hopeful signs. According to the St. Louis Fed president, it is hard to call a recession with a strong and growing jobs market.

The market had been pricing in armageddon, with pessimism running high. To put in a bottom for the market, we usually […]

Published July 8, 2022

Where have we been and where do we go from here?

Where is here and how did we get there?

There is a toxic brew of rising inflation and a slowing economy. It could be called stagflation.

The U.S. economy, guided by Federal Reserve policies, has lurched from one side of the boat to the other. It appears as though the Fed is unable to chart a straight line of growth, so when encouragement is needed, it does too much, and when a slowdown is needed, it also does too much.

The financial crisis of 2007 to 2009 was caused when the Fed, following an easy money policy, overheated the economy. Then, as a result of too much stimulus, inflation predictably followed. A reasonable dose of inflation is OK; the Fed itself has set a target rate of about 2 percent per year. But the Fed overshot their target by a wide margin and inflation slipped the bounds of the Fed and ran wild. We are in a similar, although not yet as extreme, situation today.

Then and now, easy money policy resulted from a desire to have a robust economy. Back then the housing market was stimulated by ultra-loose mortgage lending standards under Fed chairman Alan Greenspan. Variable mortgage rates promised cheap interest rates. Recently the approach was to bring interest rates to near zero, with mortgage rates reaching historic lows. Perhaps, in the background, there was a desire for low interest rates to make the increase in the national debt from the massive fiscal stimulus of the COVID lockdown easier to service.

Whatever the reason the result was cheap money and runaway inflation.

The Russian invasion of […]

Published June 10, 2022

Sell in May and go away? There is no fun until the Fed is done. Is a June swoon on tap?

All these adages come to mind in the current market environment. So, what should an investor do when considering these pearls of wisdom?

Jamie Dimon, CEO and board chairman of JPMorgan Chase, America’s largest bank by assets, recently cautioned investors to batten down the hatches. Mr. Dimon says the Federal Reserve can’t do all the things expected of it, so a hurricane is coming. It is probably good advice in any market, and certainly now. This economic environment seems more fraught than usual, with inflation, rising interest rates and a European war all contributing to a witch’s brew.

The Fed has its recipe for a solution using the tools at its disposal: raise interest rates and tighten the money supply by reducing bond purchases. It sounds like an old recipe tried before. In the late 1920s, the administration’s policy was to tighten money to fight inflation, which resulted in people losing their livelihoods and standing in food lines for bread. When confronted with the effects of his policies, President Hoover claimed that in the long run his policies were correct.  He was challenged with a riposte: “People don’t eat in the long run.” Both points of view were correct.

The Fed will have to continue to tighten the money supply. The money supply increased exponentially during the pandemic and was too easy for too long, enabling inflation to get the upper hand. The response to the monetary stimulus was overly late in coming. Now the Fed is determined to squeeze inflation out of the system, […]

Published May 6, 2022

Bull markets don’t die of old age. According to an oft used axiom, “they are murdered by the Fed.” The Federal Reserve has to get its policy just right in order to avoid killing the market. The problem is that getting it just right – like for Goldilocks, “not too hot, not too cold” – is akin to a fairy tale.

Coming to the end of a long-term bull market the Fed faces many challenges in carrying out its dual mandate of full employment and inflation control. Fed Chair Jerome Powell addressed this in his recent report on the vote by the Federal Open Market Committee (FOMC) to increase interest rates by 50 basis points, saying the Fed governors will continue to evaluate employment and inflation data before they commit to the timing and amounts of future raises.

Currently, inflation is running much higher than the Fed target rate of about 2 percent, yet its tools for fighting inflation are limited. With inflation running hot, the Fed has opted for a moderately aggressive interest rate policy, with more rate increases forecast. Such actions are challenging to the market and threaten economic growth. Without the rate increases, however, inflation will go unchecked.

Inflation can be a serious threat to the economy and economic growth, as history has shown. Runaway inflation, such as seen by Germany in the late 1920s and early 30s, can have serious social and political dislocation effects in a country. Revolutions have been fought over the price of bread. The resulting political instability has allowed demagogues to come to power.

Government spending is a strong contributor to inflation. The only thing the Fed can […]

Published April 8, 2022

The market has come not just to a fork but a crossroads.

On the one hand, there is a war in Europe that is roiling stock markets everywhere.

On the other, we have inflation leading the Federal Reserve to raise interest rates.

The war

Vladimir Putin’s declaration of war on Ukraine not only caused specific damage but also upset markets across the globe. In creating chaos in financial markets and on the ground, the war is threatening to undo the global connections created since World War II. Mutual defense pacts and commercial agreements have been tested.

As of this writing, it is not clear if the war will become a global conflict. Spread could happen if the U.S. or other NATO members and Russia come into direct conflict.

Ukraine would like the U.S. to take a more active role in the conflict, but the U.S. has so far been reluctant to escalate the situation. China remains a wild card.

At this moment, China and Russia appear to be friends. That could change. They have had border conflicts in the past. Furthermore, the price of friendship with Putin’s pariah state could be higher than the Chinese want to pay. However, China aspires to be the global leader, upending the role the U.S. has enjoyed since World War II. So, if the Chinese see an opening to further their ambition, they might take it. The U.S has made it clear that it wants China to stay out of the fray. The U.S. is not as persuasive as it once was.

If the war does spread, we can expect it to become a long and protracted struggle. Can Ukraine survive in such a […]

Published March 11, 2022

As if the Federal Reserve, struggling with elevated inflation, did not have enough on its plate, there is now a war in Europe after 83 years of peace.

Historically, Europe suffers a war about every 50 years or so. Countries there just don’t seem to be able to keep the peace. Too many countries and not enough space. However, after the horrors of World War II, with the threat of atomic Armageddon and the benefit of the American nuclear umbrella, Europe found a way to peace. That interlude was broken when Russia invaded Ukraine. Why Ukraine and why now, you may ask?

Ukraine is a rather large territory by European standards and therefore provides more living room. Hitler found it inviting in his search for Lebensraum. Putin finds it so now too; plus Ukraine is a breadbasket for Europe, and provides many commodities that Russia finds attractive.

Ukraine has historically shipped these commodities from its 18 port cities on the Black and Azov seas, which Putin is currently blockading and attacking. If he is successful in taking them, Ukraine will be blocked from shipping its products directly to buyers. Putin’s invasion and appropriation of the Crimean peninsula in 2014, unopposed by the West, was his first step in implementing this strategy. According to Reuters, Ukraine in 2022 was predicted to account for 12 percent of global wheat exports, 16 percent of corn, 18 percent of barley and 19 percent of rapeseed, with much of it going to middle eastern countries already hard-hit from diminished food supplies.

Ukraine also houses several nuclear plants, including the largest nuclear power plant in Europe, which like Chernobyl, is just across […]

Published February 11, 2022

The market finally hit a pothole, falling in and almost breaking an axle. Rising interest rates, elevated inflation and a hawkish Federal Reserve rattled the market in January; big tech stocks were the hardest hit. In intraday trading during the month, according to the New York Times, the Nasdaq fell 18.5 percent from its November high and 16.3 percent for the month. There was some recovery, however; by the end of January the Dow Jones was down 3.3 percent, the S&P was down 5.6 percent and the Nasdaq was down 8.98 percent.

The market had lived in fear of the Fed for some time. But when the minutes of the board’s December meeting were released, suggesting a more hawkish tone than was expected, the market bears stepped on the accelerator. The Fed minutes suggested that interest rate increases would come sooner than market pundits anticipated. The minutes also warned that the Fed was considering reduction of its balance sheet, thus shrinking the money supply and so further tightening credit. Bond yields trended higher, to the detriment of both bond and equity markets.

2022 is the Year of the Tiger, according to the Chinese zodiac. The Year of the Tiger exemplifies courage and the routing of evil. The market started the year in need of a new tiger in its tank.

That the Fed was supporting higher rates and tightening of the money supply should have been no surprise to markets, as the Fed had been telegraphing these moves for some time. Nevertheless, the reality was hard for the markets to hear. Except for energy (up 17.07 percent), all industry sectors closed the month with losses.

The […]