A Compass Read on Inflation, Stock Prices, and the Economy
The Fed finally achieved its long-sought 2% inflation rate, over-shooting nearly five times before addressing the issue, and now inflation is driving monetary policy, the economy, and the direction of asset prices, and will be for some time. Why must Jerome Powell & Co. continue tightening policy until something big breaks? What market dynamics suggest stocks can fall farther from here? How is the economy handling these challenges? What sound practices can guide you safely through these dangerous waters?
The fed must continue raising interest rates and removing excess liquidity from the economy (by selling Treasury bonds from its balance sheet) for two reasons: 1) to reduce demand, in an attempt to alleviate inflationary pressure, and 2) to preserve its own remaining credibility. Unfortunately, today’s high inflation is driven primarily by supply constraints, which is why it’s a global phenomenon, and which places it largely beyond the Fed’s ability to curb. On Tuesday the August inflation report came in hotter than expected at 8.3%,¹ and it did so in the midst of the most aggressive Fed rate hikes in decades. Powell has made no commitment to slow rate increases yet, nor can he until an impetus larger than 40-year high inflation emerges, but such an impetus will emerge, and when it does, Powell will revert to his dovish tendencies as a bee to an early Spring flower, so hold your bearishness loosely.
The broad stock market is down double digits in 2022 and recently entered The Third and Final Stage of a Bear Market. Doc Eifrig, of Stansberry Research, last week shared his observation that ‘equity risk premium’ has only begun to rise, strongly indicating 1) stocks have so far declined in an orderly manner due mostly to rising rates, as opposed to investor panic or deteriorating financial or economic conditions, and 2) rates are likely to rise significantly from here.² Trained “buy the dip” investors are beginning to realize the Fed no longer has their back, as are the millions of disenchanted “60/40” retail investors who are enduring their worst relative performance on record. The strong summer rally suggests a spirit of speculation remains, and that most retail investors have no bear market plan, which means they are likely to capitulate before the present bear market turns, another reason to not hold your bearishness too tightly.
Thus far, the U.S. economy has contracted modestly for two consecutive quarters under the aforementioned factors, but more serious concerns are arising:
The Dry Baltic Index, which measures bulk, dry goods shipping, is crashing, which could be signaling an earnings recession is around the corner.³
The credit market is tightening on all types of loans, making it more challenging for businesses to obtain financing, especially heavily-indebted companies.
The 2/10 Treasury yield curve remains severely inverted, the most accurate indicator for an oncoming recession.
Warren Buffet said, “Don’t bet against the U.S. economy”. Sir John Templeton said, “Never stay bearish for long”. I would humbly add that we should be investing for inflation, buying quality companies with streams of income and pricing power, and building cash for the coming bear market bottom. If you are retired, make sure your cash flows are accounted for first.
Think about it, Shaun.
“Precious treasure and oil are in a wise man’s dwelling, but a foolish man devours it.” ~Proverbs 21:20
1 CNBC, “Dow tumbles 1,200 points for the worst day since June 2020 after hot inflation report”, September 13, 2022 https://www.cnbc.com/2022/09/12/stock-futures-are-higher-as-wall-street-awaits-key-inflation-report-.html 2 The Stansberry Digest, September 10, 2022 3 Chaikin Analytics, Power Feed, “The Leading Indicator Nobody Cares About”, September 9, 2022
The opinions voiced in this material are general, are not intended to provide specific recommendations, and do not necessarily reflect the views of LPL Financial. The economic forecasts set forth in this commentary may not develop as predicted.
All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including the possible loss of principle. No strategy assures success or protects against loss.
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