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 […]

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 […]