Published July 7, 2023

As the Federal Reserve took its foot off the brakes, interest rates declined and stocks powered ahead. With the Fed’s downward pressure on the market declining, the NASDAQ in particular found reason to bid up stock prices. Large-cap technology stocks like Apple powered on, fueled by excitement over the developments in artificial intelligence. Apple closed for the first time at a $3 trillion market cap, which is more than the gross domestic product of France and many other countries. These large company stocks’ rises spread to the broader NASDAQ universe, where the slight ease of inflation and the Fed pause in rate hikes were celebrated. The NASDAQ closed the first half of 2023 up 32 percent – the largest such gain in 40 years.

For months, the Federal Reserve has kept a lid on the stock market as inflation took the spotlight. The remedy for inflation, according to the Fed, was to raise interest rates until inflation was brought under control. A year ago, the supply chain crisis was raging, and the Fed was initiating its aggressive rate-hike policy. The war in Ukraine was a few months old at midyear 2022, and China was still in its zero-tolerance phase of COVID-19 lockdowns. As July 2023 advances, the Fed largely has completed its rate-hiking campaign. The annual rate of change in inflation is about half the peak level reported in June 2022. The supply chain crisis briefly flipped to a glut, and supply chains now appear to be normalizing. China has reopened, and Russia is experiencing internal turmoil and surrendering a bit of ground in Ukraine.

Last week, the U.S. Commerce Department revised U.S. GDP […]

Published June 9, 2023

After some of the biggest bank failures in years, the equity markets have struggled. The Federal Reserve finds itself challenged to get itself right with the markets after pushing interest rates up and bringing about bank failures. In addition to the Fed reaction to market stutters, worries about the U.S. exceeding the debt ceiling brought more uncertainty and new worries. If the debt ceiling were exceeded, the government would not be able to pay its bills when due. Such an event has not happened in modern times in the U.S., so it is uncertain what that would mean for the national economy and the global one. One thing is for sure: It is extremely worrisome.

What is the direction for the Fed, the economy, and the U.S.? Without a doubt, a breach in the full faith and credit of the United States on its obligations would bring a good deal of uncertainty. By now we know that the markets do not like uncertainty.

We would expect the markets to be unsettled at a minimum. But what else? We could expect that the U.S. would find itself in the unenviable position of a debtor nation rather than the lender it has been. It is not just the foregone interest income that the U.S. is accustomed to receiving, but also the money we would owe, and not be able to pay. It would be unthinkable for the U.S., with the dollar as the reserve currency of the world, to owe money it could not pay. Fortunately, the two political parties agreed to a compromise over the weekend prior to the deadline and avoided default. That is […]

Published May 5, 2023

After a challenging 2022, global equities have gained 15 percent since reaching a low point last October. Global growth equities, led by large caps, topped value ones by the widest margin since 1999. Bond prices rose as yields declined across most maturities longer than one year. Commodity and natural resource equities declined. The euro strengthened at the expense of the U.S. dollar. A weaker dollar is positive for U.S. exporters.

U.S. equities, as measured by the S&P 500, were up 1.46 percent in April, and 8.59 percent year to date. Equity gains were largely due to a mistaken belief that the Fed will cut its benchmark target rate much sooner than previously anticipated. This helped growth sectors such as consumer discretionary, information technology, and communication services. The growth index outperformed value by the widest margin since data collection began in the mid-1970s. U.S. fixed income also posted gains in the first quarter, as markets lowered their Fed rate hike expectations. The two major yield curve spread recession indicators, the 10-year/two-year and 10-year/three-month, reached their most inverted levels this cycle and their lowest negative readings since 1981.

Some banks, with mismatched assets and liabilities, and therefore, income and expenses, cracked under pressure from the relentless rise in interest rates that started just a year ago. With the Fed’s raise on May 3, rates have risen five full points in this period. The failure of Silicon Valley Bank and Signature Bank and the fire sale of First Republic to JPMorgan Chase reminded investors of the importance of diversification, liquidity, and risk management.

We have seen what the reaction is to the possibility that the Fed will alleviate […]

Published April 13, 2023

As the Federal Reserve carried out its battle against inflation, consequences arose that were unintended: The banking system suffered the biggest bank failure in years. Silicon Valley Bank, a 40-year-old institution centered in Santa Clara, California, suffered a run and had to close. The failure was sudden. The bank had been wobbly for a brief time, but failed suddenly when a small, closely connected group of large depositors demanded their money in a classic “run on the bank.”

The bank, thought to be well-capitalized, had to close upon revelation that it had a considerable amount of its assets invested in bonds, whose value had declined as interest rates rose. When interest rates were abnormally low, Silicon Valley Bank loaded up on long-term government bonds, which were thought to be risk free. When the Fed raised interest rates at the sharpest pace in 40 years, bond prices plunged and the bank’s equity, when its assets were marked to market value, was wiped out.

The discovery of this caused venture capital funds to lose confidence in the bank’s finances and instruct their portfolio companies, who were concentrated in Silicon Valley, to withdraw their money. Paper losses became real losses, as the bank had to sell bonds before maturity at a loss. So, what took 40 years to create disappeared in the blink of an eye, because of the bank buying long-term bonds to fund demand deposits. Apparently bank regulators had flagged this mismatch at the bank for some time, but that is all they did.

With the bank run, regulators acted quickly to sell the bank, but no buyers could be found. This startling news started a […]

Published Mar 10, 2023

The Federal Reserve has embraced stopping inflation as its burden. Indeed, stopping inflation is one of its mandates. Why inflation? Because it is an insidious tax on all persons that quietly eats away any savings one might have. Inflation raises the price on everything by debasing the value of money. Historically, it has led to social upheaval, political upheaval and even, indirectly, to war. Classic cases are when money becomes almost valueless, and both working and retired people find themselves bereft.

How can inflation be stopped? One way is to slow the economy so much that only hard assets retain their value. The trick is to slow the economy, but not send it into reverse. Currently, the Fed is trying to balance a slowdown without causing a recession or worse. The Fed’s tactic is to slow economic activity by raising interest rates, which tamps down consumer spending (roughly 70 percent of the U.S. gross domestic product), real estate activity and business investment. At the moment, the Fed raises interest rates every time strong economic indicators are reported for the prior period. The Fed is always looking in the rearview mirror.

When inflation first appeared, the Fed chair dismissed it by calling it “transitory.” However, due to households’ relatively strong financial conditions, record low unemployment rates, and historically high money supply levels (M2), inflation appears to be persistent and growing stronger. So, the Fed feels bound to continue to raise interest rates to such a level that the economy is stifled. Then, as demand slows, inflation should abate.

So far, the economy is not cooperating. It has remained strong, stronger than it should be under the […]

Published Feb 10, 2023

In a replay of the good-news-is-bad-news scenario, those claiming we are in recessionary times were dealt a body blow by the latest jobs report. Despite the Federal Reserve’s valiant efforts to slow the economy, U.S. jobs soared by half a million in January. This was reported just a week after the chairman of the Federal Reserve, Jerome Powell, staked out an aggressive position for tapering off interest rate hikes.

The U.S. economy beat forecasts and delivered once again. U.S. payrolls increased 517,000 for January, nearly triple the consensus forecast of 185,000. The unemployment rate of 3.4 percent is now the lowest in 53 years.

Chairman Powell had hoped for an economy that was slowly slowing, but instead received these strong numbers. The market seized upon the “good news” and considered it “bad news.” The likely result is that interest rates will remain high for the time being and longer too, as the Fed struggles to slow the economy.

In January, the Nasdaq Composite registered its fastest start to a new year in 20 years. The tech-heavy index finished up 10.7 percent for the full month of January, compared to an 8.96 percent tumble for the month of January 2022. This year’s gains were helped by expanding price-earnings multiples that investors, particularly individuals, were willing to pay for growth stocks, due to their optimism for continued declines in inflation and expectations of the Federal Reserve winding down rate hikes.

The S&P 500 also had its best start since 2019, ascending 6.18 percent in January after declining almost 6 percent at the start of 2022. The Dow Jones was up as well, registering a 2.83 percent gain this […]

Published Jan 12, 2023

The eyes of the market are fixed on the Federal Reserve as it tries to corral inflation. When inflation first appeared in the fall of 2021, Fed Chairman Jerome Powell said it was transitory, even when consumers dealing with the ubiquitous rising prices of necessities knew better. Now he thinks it is a pervasive evil. If he was wrong before, can it be that he is wrong again? Powell is now firmly lodged in the higher and longer camp of interest rates. He does not want to repeat previous mistakes of Fed chairs easing off too soon and thereby letting the hyperinflation bubble out of the bottle.

Powell is shooting for an inflation rate of about 2 percent, but is that realistically achievable? To do so, he must slow the economy considerably. Hence, he must set a target for interest rates not only higher, but also for a longer duration. In doing so, he risks a hard landing for the economy – even a painful recession.

In the last month of 2022, nonfarm payrolls increased by 223,000 – 11.5 percent above the Dow Jones estimate of 200,000. The unemployment rate fell to 3.5 percent – a decline of two-tenths of a percentage point, but also better than the estimate. The labor participation rate remained static at 62.3 percent, yet far below its 70-year peak of 67.3 percent in 2020. Wage growth was below expectations, with average hourly earnings up 4.6 percent from a year ago but below the 5 percent estimate. Nevertheless, it’s a far cry from the 2 percent inflation target. Leisure and hospitality led job gains, followed by health care, construction and […]

Published Dec 9, 2022

To begin this month, the jobs report showed solid growth. The U.S. Department of Labor reported ongoing demand for workers, despite the Federal Reserve’s effort to slow the economy and cut inflation by raising interest rates. Employers added 263,000 jobs, even as layoffs in the tech sector grabbed headlines.

But what would seem to be good news for the economy turned out to be bad news for the equity and bond markets. Why the disconnect? Well, for one thing, a strong job market must mean the economy is strong. But a strong economy is not what the Federal Reserve wants.

The Federal Reserve wants the economy to slow. The Fed wants the rate of inflation to be about 2 percent, yet it is far from there just now. The Fed is willing to punish the economy to slow the pace of inflation. The Fed’s chosen method of crushing the rate of economic growth is to raise interest rates. The Fed continues to signal its determination to follow this path. So far, it has had minimal success.

There is a price to be paid for higher interest rates. The equity and bond markets don’t like higher rates; if rates go up, stock and bond investments tend to drop in value. So, when the jobs report went up, market values went down. Some observers believe high interest rates could result in a recession. Others hope that even if there is a recession in 2023, the economy would have a “soft landing” and not a “hard landing.” All of this makes financial markets very nervous. Hence markets stumbled, bringing full circle to the good-news-is-bad-news scenario.

In addition to interest […]

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 […]