Which will you believe, your sense of reason or your sense of sight? Galileo took two balls, one heavy and one light, and dropped them simultaneously from the Leaning Tower of Pisa to see which would hit the ground first. Before Galileo and his fellow pioneers of observational science, the leading theory belonged to Aristotle, who simply used reason to suggest that a heavier object will fall faster than a lighter object. That makes sense, but that isn’t what happened…and the science of physics was born.
Today we continue to hear that higher interest rates are going to slow down our economy. It makes sense: higher rates make home mortgages and car loans more expensive. Rates on credit cards will be higher, so it must have an impact, right? Logic may say yes, but observation says no. The Atlanta Fed GDPNow data reported through October 2 shows GDP is growing at 4.9 percent, which would be far and away the best growth we have seen since the first quarter of 2021.
The pundits who predict gloom and doom will point to high oil prices and now the longer-term interest rates that have risen rapidly. We recently pointed out that oil and interest rates were simply trading in a range, and what happened in the last few months is that they went from the bottom of that range to the top of that range. This has held true for oil thus far, however, interest rates have broken through the old high of 4.3 percent on the 10-year Treasury. They are now up to 4.7 percent, and this is scaring the market.
The same pundits that have been predicting recession for what seems like forever are still at it, and everything is selling off. Rates are up which means bond prices are down, and stock prices are dropping with it. Will this continue, or will we get a rally until year-end? It depends on whether the market sides with Aristotle or Galileo: reason may tell them that high interest rates equal bad economy, but it just isn’t working out that way in reality.
This leads to what is one of the most frustrating years in the market that I can remember, as narrative is trumping reality. We thought we had moved past this and the market was in rally mode, but here we are again with two negative months in a row and a horrible start to October. This market drop is happening as inflation continues to decline and the economy is growing faster – in other words, it doesn’t make sense.
Of course, it doesn’t have to make sense, at least not in the short term. As Keynes so famously said, “The market can stay irrational longer than you can stay solvent.” We believe this will pass, and as soon as companies begin to report earnings and let Wall Street know that the world is not ending, then the rally should resume. That is what the data tells us should happen; if it doesn’t, then we will need to be defensive. It is good to be correct, and we have been for this entire cycle thus far, but one cannot fight the market.
Hopefully, the market sides with Galileo and starts to actually observe what is happening in the economy. That would lead to a lot less gloom and doom and should lead to a strong rally into year-end. Last week a friend of mine said something that pretty much sums this up: He said he could go home and turn on the news to learn about how horrible the world is with catastrophes looming on the horizon, or he could go outside and see first hand how wonderful the world is and how fortunate we are to be here. In other words, we can all be a little like Galileo and just observe the world around us, or we can sit a listen to the Aristotles, who never let their lack of vision get in the way of their logical narrative.
We’ll choose the former.
Chuck Osborne, CFA