In our last Insight I predicted that after the Fed’s rate hike we would see the market sell off and then rally. We got that part right, but now what?
Is this the final lasting rally or just another short-lived bump? This is when I am supposed to give a bold prediction and hope that I am correct, but the truth is, I don’t know. It depends on the dance between inflation and recession. As I have said previously, the market is not afraid of inflation as much as it is afraid that the Fed will put us into a recession. So, will they?
I have always believed and continue to believe that the Fed gets far too much credit or blame for economic conditions. Sure, interest rates will have some impact, but do businesses really make go or no-go decisions based on a few basis points of interest? If a business venture is predicted to be profitable only if the Fed doesn’t raise rates by a few percentage points, then that is far too thin a margin of error. Perhaps one believes the Fed will be bolder as they were under Paul Volcker when rates peaked at 20 percent in 1981, but there is no indication that this Fed has that kind of courage.
The problem with thinking that economics has become a science is that, unlike real science, there is no control group. There is no way of knowing what the economy would be doing if the Fed had acted differently. We simply observe what the Fed does and then look at what happens. Then we give the Fed credit without much question. I’m not so sure.
Which means I am not convinced that the Fed has ever actually saved the day, nor am I convinced that any Fed other than Volcker’s has ever caused a recession. There are too many other contributors to give full blame or credit to a central bank. Currently we still have a tight labor market, and it is hard to actually go into a recession with a tight labor market.
Consumer sentiment is low, and this has led to downward pressure in the market, but does sentiment really matter? Spending is to the consumer what alcohol is to the alcoholic. When depressed the alcoholic drinks. When celebrating the alcoholic drinks. Mood isn’t the defining factor. Likewise, the consumer spends. When depressed it is “retail therapy;” when happy it is “treating myself.” It may matter in completing a survey, but it does not really matter when adding up economic activity.
In our environment with prices rising, the consumer may spend differently. Gas and food are absolute necessities and will take a larger share of the wallet, but as long as consumers have income, they will spend it. That makes a recession less likely in our opinion. However, a recession can be self-fulfilling prophesy and the more the media fixates on it, the greater the probability of it happening.
In the meantime, we expect the market to stay volatile. Good news brings big up days and bad news big down days while we search for a direction. We remain defensively positioned and ready to move in either direction once a little clarity is gained; this is the prudent thing to do at the moment.
Chuck Osborne, CFA