If you listen to all the talking heads on CNBC and Fox Business you would think that the market has had its correction and it’s time for the next leg of this amazing bull market. Investor confidence is at some level unseen in decades.
How could stocks trade at multiples such as we are seeing now, when it is apparent that one of the main crutches (for the economy and the market) is about to be cut down?
To begin with, the Fed has said, in no uncertain terms, that they will be raising interest rates and their easy money policy is going to end this March. That should be concerning but apparently investors don’t think so. Investors are not afraid!
The second fact is that there is this seemingly endless supply of cash that will constantly flow into the market whenever there is any sort of pullback. Thus making any attempt at a true correction stall. That endless supply of cash is predicated on valuations in the market so with the market trading at these lofty levels, it appears that there is a ton of cash out there.
Let’s dig a little deeper into the Fed’s moves. One, raising interest rates early on will have zero effect on the economy and are more for show than anything else. Corporations have been borrowing at an absurdly low rate for years, raising the core interest rate by 25 basis points will do nothing to slow borrowing and in turn to cool down the economy. The second rate rise will have minimal effect as well. The inflation terror that they are trying to tame isn’t interest rate connected in any way so raising rates won’t quell the beast. It’s caused by a plethora of factors, none of which are interest rate connected. Two, the ending of bond repurchase programs will impact banks specifically and I do think there will be some small incremental effect here. Banks make money. No matter what you do, they make money. Interest rates go up, they make money. Interest rates go down, they make even more money. The residual effect of the Financial Crisis in 2008 is that banks are forced to become money makers before they can become money lenders and while forcing banks to be better watchdogs of their money (or investors money) they have become much more profitable. Bond repurchases by the Fed were just another way for banks to make money. The desired effect was to have a continuous supply of cash float into the system for banks to lend and grease the wheels of the economy. Stopping those repurchases will slow the new money supply and slow the growth of the economy and slow the rate of inflation. Ok, in theory I get it and I do believe it may have the desired impact but what about those poor banks that won’t be lending billions of dollars at rates 10 and 20 times what they are paying for that cash? What about them? Will they stop lending? Will they stop making billions of dollars in profits? Fat chance.
While the Fed is closing down one window of profit, they will widen another and banks will do just fine. Whew! Rising rates have a tendency to give banks another opportunity to profit as they charge higher loan rates to their best customers. The VIG will always remain for banks so I cry not for commercial banks.
The question still remains, what will be the actual impact of the Fed ending its bond buying binge? In a 90 trillion dollar economy, how much impact will a reduction of 100 billion (give or take) dollars floating around have? I don’t think it will slow inflation but taking that supply out can’t hurt. So, we will see if it has any impact at all and I have always felt this should have been done early last year, not early this year.
Enough picking on the banking industry, what does this mean for the economy and the equity markets? In the Fed’s blinded by intelligence diagram, raising rates slowly will slow inflation because the demand component of the inflationary picture will be dampened. Less demand, less pressure on prices, less inflation. Textbook inflation and textbook inflation fighting. Great. I passed Economics 101 with a B+, so I get it but the problem is, this is not textbook inflation. The Fed refuses to get actual, on the ground inflation numbers and refuses to actually talk to regular people to figure out how hard inflation is hitting a lot of us. Real world scenarios are not part of the data that the Fed uses and it is very clear the Fed is at least two steps behind in this inflationary period. I have been on top of this from day one and I could have told them my thoughts but my only cred is my street cred and that is not useful to academics and eggheads.
If you look historically, inflation has had a mixed record as far as stock valuations go. Some periods of inflation have caused serious damage to stocks. Those periods were generally extended beyond what a normal inflationary cycle ran and the residual affect was a recessionary period. This is what I think we might be developing. A longer lasting inflationary period followed by a recession. I don’t think either period will be devastating because the economy is still fairly strong and I do think it can weather both without a long lasting impact. So, your long-term investing goals are probably still a safe bet. Short term, I am not so sure.
The fourth quarter has been producing some fairly decent earnings numbers and that was a bit of a surprise I must say. I do not expect to see those types of numbers in the first and second quarters. Mainly because the comparison numbers will be hard to beat. The first and second quarters of last year were excellent and to see that sort of earnings growth again would be unprecendented (Maybe after WWII, but not since). Trust me, they will be fine but just not the 20-30% growth we have seen over the last 12 months. With this normalcy returning, will stocks keep up this bullish arc? I don’t think so. With Tech stocks probably becoming the most volatile sector again, there will be whipsaws in the market and those whipsaws will see a slowing of the bullish trajectory and reality setting in.
What you will have in 2022 is this. Inflation will stay longer than anyone wants, Interest rates will rise but not to damaging affect. Markets will bounce around a lot more than they did last year and the new highs will be less frequent as the trend levels off and the range will narrow as the year goes on. I still think there should be a solid correction where we actually have some sort of real capitulation.
Speaking of capitulation, please do not listen to anyone on any network tell you that a sell off is a capitulation. They have no idea what they are talking about. Anyone who has been trading and been in the business for more than 20 years can tell you when they see it. What happened in FB (Meta or whatever they call themselves today) was capitulation. The blindly selling an asset to raise cash is not capitulation. It is desperation. Selling with tremendous momentum and no apparent plan is capitulation. Experienced players know it when they see it. Harvard MBA’s don’t.
Another Excellent article. Your points are understood and well taken. Special reference to your last paragraph, which put you over the top! I love the way you man handle the networks, starts my week with a smile. Thank You!