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 […]

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 […]