Does the Fed have any real power?

Wall Street strategists are far more bearish than Wall Street analysts. The strategist community sees the current situation as driven by the actions of the Federal Reserve; the theory goes that the Fed raising rates will cause economic activity to slow down, the economy to go into a recession, and the market to crash. This argument seems logical, but it ignores a significant factor and makes some assumptions that might not hold true.

First, it ignores the fact that the market has already dropped well into bear market territory. Secondly, it assumes that Fed actions have a significant impact in the real economy.

How does the increase in interest rates impact companies? There are two possible ways. First: If they sell a product that requires most customers to use financing, but most businesses do not sell products that are so expensive that their customers must finance them. Second: If a company must borrow a great deal of money to run its operation, the interest expense on that debt would cause earnings to go down. In the manufacturing days of the 1970s and 80s this was true, but is it today?

Analysts, on the other hand, see the world from the bottom-up, and it simply does not look so bad from that view.

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~Fourth Quarter 2022

Does The Fed Have to Pivot?

For those who pay attention to financial pundits, the word “pivot” is becoming very familiar. These sources of pseudo-wisdom keep saying that the stock market cannot maintain a rally until the Federal Reserve pivots from a policy of raising interest rates to a policy of lowering interest rates. They are, as usual, wrong, but there is something bigger afoot here:  This modern idea that we must be on one extreme or the other. In this case the Fed must be either raising interest rates to fight inflation or lowering interest rates to fight a recession. This is absurd; The Fed can just hold steady, maybe provide some stability.

The Fed is overrated. They have undue influence on financial markets, but how much control do they really have over the real economy?

We are battling inflation today which, to a large extent, has been driven by rising gasoline prices. One of the main drivers of high gas prices is the lack of refining capacity. Under today’s regulatory environment, opening a new refinery would be next to impossible. The Fed can raise rates forever, but that will not refine a single gallon of gas. Increasing refining capacity will require some regulatory reform.

To read the full report, please download the PDF.

~Third Quarter 2022

As our economy slows and inflation remains stubbornly high, one must wonder if we will ever learn our lessons. We have been here before and we know what causes this, yet here we are once more. We did not learn the lesson of the 1970s; but why?

Macroeconomists are too fixated on aggregate demand. They believe that if aggregate demand is stimulated – through low interest rates or government spending – then supply will simply react. Supply didn’t react in the 1970s, and it is not reacting now; hence, inflation.

In the 1970s the Fed raised interest rates to lower aggregate demand, but then policymakers countered that action. For example, Nixon implemented price controls, which actually stimulated demand while curtailing supply. The result was shortages; growth slowed further, and inflation persisted.

The Fed did eventually raise rates again and kill inflation, but they had the help of the Carter and Reagan administrations, which both freed up supply through regulatory and tax reform. That is what it took then, and that is what is needed now.

“Those that fail to learn from history are doomed to repeat it.” ~ Winston Churchill

To read the full report, please download the PDF.

~Second Quarter 2022

The war in Ukraine has put a fog on the market. The rising cost of oil exacerbates the already high inflation, and there is significant risk of a recession in Europe. China was already having issues with its economy as its regime continues to reverse the liberating reforms.

There is lots to worry about as an investor, which is why we have seen a market correction. Corrections are not fun – in fact they are scary, as it always seems this could turn into more than just a correction. There are always arguments for why this time it is really the end of days, and the market will go to zero. That causes stress and stress literally causes tunnel vision, and all we can focus on are the negative news items, of which there are plenty. It is like being in a fog – one cannot see anything around them, only what is right in front of them, which today is the conflict in Ukraine, runaway inflation, and slow economic growth. Eventually the fog lifts and the world reappears. When it does – and it may already be happening – there are opportunities for investors. It may not seem like it, but then it never does.

To read the full report, please download the PDF.

~First Quarter 2022

What is the real rate of growth? GDP growth rebounded in the 4th quarter of 2021. After slowing to 2.3 percent in the third quarter, the initial reading for 4th quarter is 6.9 percent. Does that mean we are back to the solid growth of earlier this year? It doesn’t feel that way.

While 6.9 percent seems like healthy growth, we must factor in that inflation is 7 percent. Also, when you average the 2.3 percent and 6.9 percent, the second half grew at 4.6 percent versus over 6 for the first half. Is it any wonder that people do not feel as if the economy is doing well?

Factor into that 6.9 percent growth the fact that more than 4 percent of that was inventory-building, and the picture becomes a little bleaker. Most of the activity last quarter was simply companies getting their supply chains sorted.

This puts the market in a quandary. Earnings will be strong, at least in nominal terms, while real growth continues to slow. In the long term company earnings should win out, but in the short haul, markets are likely to be choppy.

To read the full report, please download the PDF.

~Fourth Quarter 2021