Published December 8, 2023

As we arrive at the end of the year, all eyes still turn to the Fed. Interest rates continue to be the focus. The 10-year Treasury has declined 80 basis points from the beginning of November, when it had been flirting with rising over 5 percent, to reach a recent low of 4.2 percent.

The stock market responded with a robust rally, which broke a three-month losing streak. November lived up to its winning reputation, with monthly gains of nearly 8.8 percent for the Dow, 8.9 percent for the S&P 500 and 10.7 percent for the Nasdaq. Historically, November is the best month of the year for the stock market, and December is third, according to the Stock Trader’s Almanac.

The market was able to push higher, despite Federal Reserve Chairman Jerome Powell saying that talk of cutting interest rates is “premature” and that more hikes could still happen. Many equity and bond investors assumed the Fed was done with its tightening cycle now that inflation and job growth have shown signs of moderating. Both sectors rallied, pushing the 10-year Treasury to its lowest level in years.

Proof that the Fed’s battle with inflation is working came when the central bank’s key inflation gauge continued its downtrend. The core PCE (Personal Consumption Expenditures) price index, which excludes the food and energy sectors, in October rose 0.2 percent for the month and 3.5 percent year over year. Both gains were lower than estimates. Furthermore, the ADP National Employment report showed that private payrolls in November increased by 103,000 jobs, which was below economists’ expectations of 130,000 and below the 250,000 jobs generally thought necessary to replace […]

Published November 10, 2023

Once the Federal Reserve started on its tight money policy trajectory, the equity markets and the economy diverged. The economy has been generally strong, while the stock market has struggled under the weight of ever-increasing interest rates.

At the close of October, stocks had registered a third straight month of declines, with the Dow down 1.3 percent, the S&P down 2.1 percent and the NASDAQ off 2.8 percent. Two days later, U.S. equity markets treated investors to the biggest weekly gains in a year. Ostensibly, this rally was caused by traders closing out short positions before the weekend due to a trifecta of good news that occurred in the last three business days of that week.

The stock market was boosted first by a pause on rate hikes by the Fed on Wednesday, second by a good enough earnings report from Apple on Thursday (Apple being the dominant stock in the NASDAQ index and in most equity funds), and third by a soft jobs report on Friday. This good news about the economy’s resilience, despite lower employment, allowed major indexes to clear significant benchmarks. The Dow Jones had its best week in a year, up 5.1 percent. The S&P and NASDAQ also had their best weeks since November 2022, up 5.85 percent and 6.6 percent, respectively, for the week. The tech-heavy NASDAQ index managed to close above its 50-day moving average – an encouraging development for stock market bulls. The NASDAQ was now up nearly 30 percent for the year. The S&P 500 followed close behind, also bullishly climbing above its 50-day moving average to a gain of 14 percent for 2023 year to […]

Published October 5, 2023

We have been in a long-term bull market, but now we seem to be coming to the end. An old adage is that bull markets don’t die of old age but are murdered by the Federal Reserve. Is that what is happening now?

Looking back, we see the market recovering from deep recessions in the early and later 2000s. When the market was in a deep trough, the Fed worked hard to lift it out of recession. The Fed proclaimed “quantitative easing” as the solution: lowering interest rates, including its lending rates to banks, and flooding the markets with cheap money by buying U.S Treasurys. The Fed forced money into the economy to lift it, while driving the cost of money unsustainably low. Modern monetary theory it was called. Congress added to the huge growth in money supply by creating ever-increasing deficits, funded by borrowing by the U.S. Treasury. The Federal Reserve bought this debt as did China and other countries with massive trade surpluses, such as oil-producing nations.

When the pandemic came, there was even more pressure to have deficit spending.

The budget deficit reached almost $1 trillion in 2019. That was nearly 4.6 percent of GDP, while the historical average was 3 percent. By FY 2020, the deficit was $3.1 trillion and by FY 2021 it was $2.8 trillion (14.7 percent and 11.8 percent of GDP, respectively). In 2022 it was 5.3 percent. As of August 2023, these deficits have accumulated to total about $33 trillion in national debt, which is increasingly being funded at current interest rates, thereby adding to […]

Published September 8, 2023

The market began the year on an up note, but reversed course in the summer, leading to a choppy year so far. It has been at the mercy of Federal Reserve Chairman Jerome Powell, who has remained steadfast in his dedication to lower the inflation rate to 2 percent.

As interest rates increased and the threat of more increases prevailed, the market tumbled. Conversely, when rates decreased, the market rallied. The ride has been volatile.

In the meantime, the economy continued to appear strong, yet threats of a recession held on in the background. Chicken Little was everywhere, threatening a recession that did not arrive. At one point the NASDAQ had gained nearly 29 percent, showing a strong economy that was thwarting Powell’s effort to break the back of inflation.

As the Fed appeared to be at or near the end of its cycle to tighten interest rates, economists were anticipating no more than one more increase of 25 basis points in short-term rates. The economy remained healthy.

With memories of bank failures fresh in its mind, due in part to the rapid increase in interest rates over the past 18 months, the Fed retained a cautious posture. In the meantime, Moody’s and Standard and Poor’s rating agencies put a number of regional banks on credit watch, sending a chill through the market. The economy began to cool. Consumer sentiment also cooled. Investors became suspicious about the Fed’s strategy to fight inflation. Wall Street thinking changed to believe that the Fed might possibly continue elevating rates to above 6 percent and not cut them. The market reacted negatively.

The bull case for the market right now is […]

Published August 4, 2023

One day while sitting under an oak tree, an acorn fell upon the head of Chicken Little. She looked everywhere but could not find what had hit her. She concluded that what had fallen on her was part of the sky and decided it was so important that she had to tell the king. So off she ran to tell him that the sky was falling. She ran as fast as she could. Along the way she encountered friends who asked her why she was running so fast. She told them what had happened and that the sky was falling. Alarmed by this news, her friends joined her in running to tell the king, all of them yelling that the sky was falling. The king assured them that the sky was not falling.

Recently, a similar popular mantra has been that we must have a recession to slow inflation. People took up the recession alarm, until recently reported robust big bank earnings suddenly inspired economic optimism. All three of the largest banks beat analyst expectations for revenue and earnings. JPMorgan Chase’s earnings jumped 67 percent from a year earlier. Wells Fargo’s income was higher by 57 percent. Collectively, the three biggest banks earned $49 billion in net interest income in the most recent quarter – up 31 percent from the previous year.

Not only did the loans increase, but banks charged more. Loans to businesses increased. Higher credit card balances represented more loans to consumers at elevated finance charge rates. Even mortgage originations increased. The banks lifted their forecast for 2023 profits related to lending.

Previously, analysts sounding the alarm had forecast that the economy […]

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 […]