Let’s face it. The fed is one of the most criticized entities on the planet. Hindsight is always 20-20, but it’s amusing to break down their every move before and after they make any decision (and I mean literally ANY decision LOL). I always picture someone like Kyla Scanlon interviewing J Powell after a fed meeting like Lisa Salters interviews Steph Curry after a big game.
I thought it would be prudent to break down what’s going on with the economy, and what the fed has been doing/did in their last meeting. Taking a peek under the hood allows you to draw more educated conclusions. It’s a good learning experience, but also an excuse for the memes :D
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What Do They Do?
The fed’s job is to manage expectations. They accomplish (or try to) this through pulling the various “levers” at their disposal – including the interest rate “lever”. Inflation is running rampant as the economy has heated up since the onset of the pandemic and record amounts of stimulus was pumped into the economy. This combined with supply chain woes and geopolitical tensions has led to a sticky situation. Inflation is the product of too many dollars chasing too few goods. Demand is higher than supply (prices increase). It’s the fed’s job to try and cool a heating economy and bring things to equilibrium.
Essentially, increasing interest rates is the fed’s tool for lowering demand, and allowing supply to catch up. They want to discourage spending and unfortunately, in the process, push people out of work (the start of a recession).
As the last CPI data still showed high ratings (even though they mostly came from energy, more on this later), the fed announced a 75bps a couple days ago, with some even calling for 100bps, (Bill Ackman actually making a correct prediction after getting absolutely ratioed for his infamous pandemic comments). The expectation was the fed hiking AT LEAST 50bps every fed meeting for the rest of the year.
Unfortunately, it looks as though capital markets have lost confidence in the fed. The fed wants to make sure they don’t lose their credibility. Therefore, they’re trying to balance a softish landing and trying to “walk the walk”. The bad news about a “softish landing” (essentially the fed trying to reset the economy without a recession) is historically, it doesn’t really work. In the times a “softish landing” worked, it was because the rates were lowered back down after the increases. So essentially they're increasing interest rates aggressively so they can swoop in and lower them later to save us from....themselves?! This is where the criticism probably lies.
The GOOD NEWS: this is an unprecedent time brought about by an unprecedent event – the pandemic. Therefore, there might be a different ending than most historical ending shows. Who knows. In short, the fed aims to bring the economy catharsis as they continue to manipulate rates.
What Has Happened? (This is being written during the week of 6/13/2022.)
To be frank, a decrease in asset prices.
The S&P is in a bear market.
Fears of a looming recession.
Consumer sentiment plummeting because of high food, gas, and rent prices.
To name a few…
What Hasn’t Happened?
A collapse in margins and earnings. Higher unemployment.
Although consumer sentiment is low, the consumer is still, well, consuming. Inflationary pressures are somewhat passthrough for businesses, meaning they can pass the pressure through their prices. And the consumer is still buying, even with prices being elevated (shown in retail sales falling slightly but still above trend). Eventually, consumer demand should go down, which will hurt businesses free cash flows which will then lead to people being forced out of work. It’s a weird time – some fundamentals are still holding up.
Although consumer sentiment is low, unemployment also remains low which may be the last domino to fall. Again, as spending decreases, businesses want to keep earnings high so layoffs will begin to happen, and unemployment will increase.
However, the market is usually forward looking, so maybe the recent spiral in capital markets is with the margins and lower earnings baked in. Again – who knows.
What’s going on with gas prices and the housing market?
It’s no secret that the consumer is losing confidence in the energy and housing market.
First off, contrary to popular belief, the fed can’t directly control gas prices or create more oil. The problem with the energy crisis is mostly stemming from refineries shutting down and the oil shock stemming from the war. The only thing the fed can do is again, manage expectations and try to control demand.
On the other hand, mortgage rates are increasing rapidly because of the rise in interest rates. Remember, rising interest rates makes it more expensive to borrow money and take on debts (thus discouraging spending). This is quelling demand and cooling the housing market, but now the demand for rent is going up, making rent prices also increase.
Moving Forward?
Remember – control the controllables.
You can’t control what the fed does (don’t fight the fed). And you can’t control price movement of a stock.
But you can control the following: your risk tolerance, time horizon, goals, saving rate, spending, asset allocation, emotions etc. As a long-term investor, you should strive to be taking advantage of any bargain in the stock market, especially one of this magnitude. As any investor, it is crucial to be proactive and not reactive as volatility continues. Missing out on the best days during periods of heavy declines can be detrimental to long term portfolio return. We recommend proper asset allocation to manage your risk for long term returns. When the tide goes out, we’ll see who’s been swimming without a bathing suit.
More specifically, what is performing well in capital markets up this point? Energy and Utilities -- defensive stocks. More traditionally, these are late cycle stocks. Conversely, early cycle equities have seen a bad tailwind, which are consumer stocks. An eventual higher allocation to these sectors may be prudent depending on the timing of a recession. (Have fun trying to figure that one out)
AND THAT’S IT. You can blink now. I hope this gets everyone as excited as I am for the next FOMC meeting!! Happy Pizza Friday!! (I'm forward looking, just like the market)