To make a very long story very short, a single investment rule would have served you very well from 1982–2022. Wall Street pros expressed it crudely: BTFD. (Buy the F…ing Dip.)
What simple rule works today? STFB (Sell the F…ing Bounce)?
On Friday, the financial press was worried about the latest wobbly bank. Bloomberg: ‘Deutsche Bank Shares Plunge in Renewed Bout of Stress’:
‘Deutsche Bank AG became the latest focus of the banking turmoil in Europe as ongoing concern about the industry sent its shares slumping the most in three years and the cost of insuring against default rising.
‘The bank, which has staged a recovery in recent years after a series of crises, said Friday it will redeem a tier 2 subordinated bond early. Such moves are usually intended to give investors confidence in the strength of the balance sheet, though the share price reaction suggests the message isn’t getting through.’
The message? ‘Don’t worry. We’ve got your backs.’
Investors seemed to believe it. Stocks bounced, with the Dow up for the second week in a row.
But let us answer Jerome Powell’s question: what happened?
For decades, stocks rose as interest rates fell. Then, beginning in the late ‘80s, the Fed made low interest rates a matter of policy. Stocks continued to rise. Investors learned to BTFD. By 2009, the Fed was lending money below the rate of consumer price inflation. By this stage, stock analysis no longer mattered. Crazy investments, with no hope of ever actually earning money, soared.
‘Don’t worry about it’, said the pros. ‘Just BTFD.’
Meanwhile, since 1974, the federal government ran in the red (with the exception of a few years during the Clinton Administration). In 2020 it went Full Stupid and handed out trillions of dollars in stimmy/PPP cheques. In 2021, Joe Biden added another US$1.7 trillion in his Inflation Reduction Act. The Fed’s balance sheet — roughly measuring the amount of money and credit at large — rose 10 times from 2000 to 2022.
Inflate or die
The result was higher consumer prices…which the Fed began to ‘fight’ with small increases to its key lending rate. But after more than 12 months of increases, the Fed Funds Rate is still trailing consumer price increases by 100 basis points (1%).
Ultra-low interest rates, for an ultra-long time, led to today’s US$90 trillion debt and today’s wobbly banks. Now, as interest rates rise, that debt burden — like a conscience haunted by an old sin — becomes intolerable. Households can’t pay their mortgages. Businesses can’t refinance their bonds. And banks find that their long-term assets (including Treasury bonds) are worth less than their short-term obligations to depositors.
And there you have the stark choice. It’s ‘inflate or die’. Either the government inflates away the excess debt…or the bubble epoch dies (deflation).
Our old friends, James Dale Davidson and Lord William Rees-Mogg developed the idea that there were political dynamics bigger…and deeper…than the bickering between Republicans and Democrats we see on TV. ‘Megapolitics’ they called it. Those are the forces behind our forecast: that the deciders have too much at stake to allow deflation. The only alternative — the time-honoured resort (along with war) of scoundrels and megalomaniacs — is inflation.
What does that mean for the stock market? In the near term, it’s hard to say. Stocks often go up as investors look for alternatives to fixed-income bonds. Sometimes they go down, as consumers’ real incomes fall, along with business profits.
But over time, bad money weakens trust in public institutions…in banks…in the currency…in the future — and the whole economy suffers. Almost everyone gets poorer. Some businesses — those that offer real goods and services at good prices, with decent profit margins — continue to offer decent earnings. Others fail.
What can you do?
For The Daily Reckoning Australia