‘Every sunset brings the promise of a new dawn.’
Ralph Waldo Emerson
Back home on the range, after two days on the road, we take stock. Has anything important changed?
Are the economy and the markets still following the script we laid out?
My colleague Tom Dyson just asked dear readers what they thought of our service. Many remarked that your editor was ‘too negative’.
Whew! We worried that we were too positive. We were afraid we hadn’t warned you with sufficiently lurid details about the crash, depression, hyperinflation, revolution, war, poverty, and mass death ahead.
Nevertheless, today, we’ll respond to popular demand. We’re not changing our tune. But we’ll try to be more up-beat about the coming catastrophe.
Buying the market
You’ll recall that Wall Street was once a market for stocks and bonds. Each one was analysed, inspected, weighed, and judged. Investors looked for the best of them and traded them with each other, depending on their guesses and opinions.
Then, the Fed came into the picture…cautiously…gradually…and then emphatically. Marty Zweig was among the first to notice that Wall Street had become something different…no longer a market of stocks, now it was an investment of its own…a ‘stock market’, that investors could use like a gambler used Las Vegas…as a place to make his bets.
Instead of doing any real studying, an investor could just ‘buy the market’…perhaps by getting an ETF…and his fortunes would rise (or fall) with the stock market itself.
Zweig noticed, too, that the key to succeeding in this new market was to understand the role of the Fed.
‘Don’t fight the Fed’, he advised.
After stopping inflation with a 20% Fed Funds rate in 1980, Fed policy pushed rates down and the stock market up for the next 40 years. From 1982–2022, the Dow doubled once…twice…thrice…four times…FIVE TIMES.
But in 2020, the bond market topped out. Interest rates hit record lows (when bonds go up, yields go down)…and then began an historic move up. A four-decade bull market in bonds (with lower and lower yields) was over.
Measured in real money
Last year, the Fed changed course, too. It’s now raising rates and lowering stock prices. Here’s the Wall Street Journal:
‘The Fed has been trying to curb investment, spending and hiring by raising rates, which makes it more expensive to borrow and can push down the price of assets such as stocks and real estate. The fed-funds rate influences other borrowing costs throughout the economy.’
Speculators have been slow to understand. They put their ears to the rail…listening carefully for sounds of that coming Pivot Express. They’re sure it is rolling their way; soon they believe things will return to ‘normal’. In the meantime, they are still ‘buying the dip’ and expecting a return to booming markets with super-low interest rates.
As we’ve pointed out, there was little ‘normal’ about the last 22 years. And stocks do not always go up. So far in the 21st century, even the greatest investor of all time — Warren Buffett — has not made a penny. Not in real money, gold.
Is this beginning to sound ‘negative’? Well, let’s look at it from the bright side. The US has been on the decline…with fake money…fake wars…and fake prosperity for the last 22 years; happily, Buffett’s flagship company, Berkshire Hathaway, hasn’t lost value. Priced in gold, it is neither more nor less valuable than it was in 1999.
That brings us up to date. There has been no real change in the program since the bond market hit bottom and the Fed changed course. Interest rates up; asset prices down.
And from here on out, there’s nothing but good news:
Currently, consumer, business, and government debt are still going up. Borrowing puts more money in circulation, which causes prices to rise (inflation).
Sunny side of the street
Thanks to the Fed’s error — keeping interest rates far too low for far too long — we have far too much debt, much of which can never be paid. But (more positivity!) that’s what recessions are for. Trying to stop recessions and corrections is like preventing episodic forest fires. The dry tinder just builds up — creating an even bigger danger.
That’s what has happened. Like fallen limbs and pine needles, the US has accumulated some US$90 trillion worth of debt, including about US$50 trillion in ‘excess’ tinder (above traditional norms). Good news for a pyromaniac!
So…on with the sunny-side-of-the-street weather outlook:
For now, all is hunky dory. Low unemployment (as measured by the feds)…and satisfactory consumer spending (thanks to borrowing) allow the Fed to continue its policy of raising rates, without really causing much pain. Said Jerome Powell:
‘The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.’
And (will the good news ever stop?!) the Fed’s higher rates will probably have the effect the Fed desires — stocks will fall, interest rates will rise, borrowing will go down, consumer spending will drop off, and jobs will disappear. And debt will decline — either by defaults, bankruptcies, and write-offs…and/or, later, by inflation.
Yes, there’s a small shadow over our otherwise sunny report. It’s easy to turn down a hamburger when you’ve just eaten a steak. It’s much harder when you are starving. When the lean days come — when stocks crash, and the economy goes into a recession — we expect Powell’s appetite for a ‘pivot’ to be irresistible.
And he’ll have plenty of company. Yes, the Fed is subject to the same fads and trends as the rest of the government. ‘Diversity hires’ at the Fed are likely to favour more government, bigger deficits, lower interest rates, and looser monetary policies.
It would be a ‘serious mistake’, said Larry Summers, to load up the Fed with wokish, dovish, leftist deciders. It would cause people to expect more inflation, and thereby ‘put more inflation premium into interest rates…likely to lead to higher long rates, which means higher mortgage rates for the very people progressives are trying to help’.
Even there, the glass is half full as well as half empty. The housing sector has begun a decline already. Higher mortgage rates will give it a shove, helping it get where it is going sooner. Higher prices…and higher mortgage interest rates…will prevent people from buying houses they can’t really afford.
So you see, dear reader, everything always works out for the best.
For The Daily Reckoning Australia