Category: Economy

Paper Hands and the IRS

Posted on by cpatches
Image Credit: Phillip Ingham (Flickr)

Selling at a Loss Near Year-End Could be Financially Worthwhile

Calling someone “paper hands” is common in online trading communities such as r/wallstreetbets. It borders on a bullying tactic to encourage others on the platform to remain in stocks that have weakened. The main reason is that many in the community own and have taken a “diamond hands” position. Investors should consider that the tax code may reward those investors that are looking out for themselves first and the chat board community second. 

The first three-quarters of overall market performance in 2022 can only be described as ugly. Each portfolio is likely to have its share of losses. Many investors can make a little lemonade out of the abundance of lemons that may be in their portfolios. But first, they need to take steps to harvest these lemons.

Tax Loss Harvesting

While there are many reasons that taking a loss is uncomfortable, the reason one invests in the first place is for financial gain. Playing the cards you’re handed at all times is considered prudent investing. Taking and using them to help reduce one’s tax bill can make financial sense. The tax consequence decision to sell below-cost investments and use the losses to offset gains from other investments or ordinary income is referred to as tax loss harvesting.

An example of how tax loss harvesting could help an investor financially is this. An investor will sell one or more of their negative on-the-year investments and recognize a loss. The investor then uses these capital losses to offset capital gains and/or W2 or 1099 income. If losses exceed gains by $3,000 or the losses taken up to $3,000, can be used to offset ordinary income in the current year. Amounts above $3,000 can be carried forward and used in future tax years.

There is one more step, investing in something else. The investor can either maintain their sector allocation or invest in something completely different. Buying back the same issuer name is an IRS no-no. The investors’ exposure to the overall market remains intact, but there is a $3,000 reduction in earned income or capital gains.

Wash Sale Rule

There is a link below this article to the IRS website; before executing a tax strategy, it is recommended you visit the site, and if not clear, consult your tax advisor.

One way investors have gotten themselves in trouble with the IRS is by selling a security at a loss and then reacquiring the same or substantially similar investment. If you sell a security and claim a tax loss on that sale, the Internal Revenue Service’s guidelines, commonly referred to as the “wash sale,” rule will require you don’t reinvest in the same issuer.  

The wash sale rule outlines that investors cannot buy a “substantially identical” security 30 days before or after the sale of the funds chosen when conducting tax loss harvesting. This doesn’t mean the investor has to buy an investment in a completely different industry. For example, if an investor sold a silver mining company stock to harvest a tax loss — but still wants mining exposure — they could potentially buy a new or different stock within the industry.

Take Away

Taking an investment loss means a hard dollar recognition of the loss and recognition that you judged wrong. But, investing is always about maximizing financial gain. Investors that are correct 25% of the time often beat those that are correct 60% of the time. So needing to be correct could actually hurt performance. Understanding the other financial moves investors can make to maximize their overall finances can incrementally benefit their personal balance sheet.

While belonging to a consortium of investors that are stronger when sticking together is comforting, one must recognize that when it comes to investing, most will do what is best for themselves first. There is no guilt in protecting or maximizing your own finances legally.

Channelchek is a niche community of small and microcap investors. We believe in leveling the playing field by providing the exact same research and analysis to individuals at no cost that the most revered hedge funds in the country download from expensive services they subscribe to. Sign-up to receive this equity research each morning.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.irs.gov/taxtopics/tc409

https://www.nasdaq.com/articles/the-advisors-guide-to-tax-loss-harvesting

Do Low Mortgage Rate Homeowners Feel Handcuffed?

Posted on by aweinsoff@channelchek.com
Image Credit: Julie Weatherbee (Flickr)

Homeowners With Low Rates May Keep Inventories Low and Prices Stable

For many, the largest single asset they own is their home. While many investors are concerned about what rising interest rates may mean for investments in the stock market, homeowners are keenly aware that rates can directly impact home prices as most borrow to buy. The amount they can borrow is directly related to their cash flow, so the purchase price they can afford rises and falls with mortgage rates. This impacts demand and offer prices. But what does it do for the supply side of the pricing mechanism?

Rate Increases and Homes on the Market

Mortgage rates over the past year have risen from the low 3% range to the low 6% range for traditional 30-year loans. Typically the period in the rate cycle when mortgages begin to rise corresponds to a Fed tightening cycle, as it has in 2022. While rates were lower, buyers were able to afford “more house” and allowed sellers to push up asking prices – or in some cases, buyers would have had a bidding war driving up a home’s price.

As rates increase and it then costs borrowers more each month for the same price, buyers lessen. Home prices initially don’t decline as quickly as sellers would like as home sellers are stickier on the way down than they are on the way up. As with any investment, until you book your profit/loss, it’s just paper gains/losses. And homeowners don’t like to think of themselves as having “lost” thousands because their house once would have fetched more. So home buyers sit and wait, which in the past has caused inventories to increase. Eventually, there is capitulation among homeowners, and many houses hit the market with lower prices attached to them.

This has not happened yet during this rate cycle, and there is an underlying reason that may prevent it from happening. Existing homes are not entering the market as expected.

Homes for Sale are Scarce

The Wall Street Journal published an investigative piece on the real estate market and how Homeowners with low mortgage rates are stubbornly refusing to sell their homes because it would mean they’d have to borrow at much higher rates for wherever they may move. 

The Journal reported that housing inventories had risen somewhat from record lows earlier in 2022. But this is primarily because they aren’t selling as quickly. The number of newly listed homes from mid-August to mid-September fell 19% from the same weeks last year. This suggests that those that may have sold to move for any reason are staying put.

The explanation for this unexpected phenomenon is that most that have purchased or refinanced their homes in the past few years have historically low mortgage rates. Imagine having 2.75% locked in for 30 years and knowing that if you purchase the home in the next town with the extra bedroom, your rate will be 6.25%. Potential sellers are opting to make do.

Homes will always enter the market regardless of dynamics. People die, change jobs, get divorced, the kids move out, etc. But, if those who have the option not to move decide to stay in larger percentages than in the past, it could keep the inventory of homes for sale below normal levels. The low supply could keep home prices elevated.

Another option someone who would like to move has is to rent. Rents have been quite high; this would serve to reduce the upward pressure on tenants. It would also keep homes from entering the market, allowing them to retain values better than might be expected with higher mortgage rates.

The scarcity of homes on the market is one of the primary reasons home prices have retained their high levels, despite seven straight months of declining sales in a period when interest rates have roughly doubled since December.

Handcuffed by Low Rates

There is a term used on Wall Street for employees that feel they can’t leave their company because they have vesting interests worth too much. For example, my friend Katherine was granted stock options from her company, the ability to exercise the options vested over a few years. At any point, if she left to take another position, or as she told me she wanted to do, raise children, she would have been leaving a huge sum of future stock or cash behind. Homeowners with mortgages near 3% when rates are near 6% have found their situation similarly handcuffs them and drives greed-based behavior.

Today Millions of Americans are locked in historically low borrowing rates. As of July 31, nearly nine of every ten first-lien mortgages had an interest rate below 5%, and more than two-thirds had a rate below 4%, according to mortgage-data firm Black Knight Inc. About 83% of those mortgages are 30-year fixed rates.

Can it Last?

Homeowners looking for more space are now more likely to add on than they had been before. For those looking to scale down, they may find that it isn’t worth it. In an analysis of four major metro areas—Atlanta, Chicago, Los Angeles, and Washington—Redfin found that homeowners with mortgage rates below 3.5% were less likely to list their homes for sale during August compared with homeowners with higher rates.

It is difficult to predict any market, and there is very little history to look back on when rates have been increased this quickly. Sam Khater, the chief economist for Freddie Mac, told the Wall Street Journal an analysis he did in 2016 of past periods of rising rates showed a decline in sales in which a buyers’ prior mortgage rate was more than 2% below their new mortgage rates. But there was no change if the difference between the rates was less than two percentage points. We are likely to retain more than a 2% margin for some time based on how low homeowners’ mortgages now are. Perhaps until many of the loans are paid off.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.wsj.com/articles/after-years-of-low-mortgage-rates-home-sellers-are-scarce-11663810759?mod=hp_lead_pos3

https://www.blackknightinc.com/data-reports/?

September’s FOMC Meeting and Powell’s Unflinching Resolve

Posted on by cpatches
Image Credit: Federal Reserve (Flickr)

The FOMC Votes to Raise Rates for Fourth Time

The Federal Open Market Committee (FOMC) voted to raise overnight interest rates from a target of 2.25%-2.50% to the new level of 3.00% – 3.25% at the conclusion of its September 2022 meeting. The monetary policy shift in bank lending rates was as expected by economists, although many have urged the Fed to be more dovish, others suggest the central bank is behind and should move more quickly. The early reaction from the U.S. Treasury 10-year note ( a benchmark for 30-year mortgage rates) is downward slightly, while the S&P sold off 26 points and the Russell 2000 remained unfazed. Equities later sold off as the Chairman held a press conference.

The statement accompanying the policy shift also included a discussion on U.S. economic growth continuing to remain positive. The FOMC statement said recent indicators point to modest growth in spending and production. Job gains were also seen as strong in recent months, and the unemployment rate remains low.

However, the statement points out that inflation remains elevated. The Fed believes this reflects supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.

Russia’s war against Ukraine is causing tremendous human and economic hardship, according to the Fed. The statement indicated the inflation risks related to the is an area they are paying attention to.

Source: FOMC Statement (September 21, 2022)

The Federal Reserve made clear it was continually assessing the appropriate actions related to monetary policy and the implications of incoming information on the economic outlook. The Committee says it is prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede reaching the Committee’s goals. This is to include a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments, according to the statement.

Source: Federal Reserve Board and Federal Open Market Committee release economic projections from the September 20-21 FOMC meeting

Each member of the Federal Open Market Provides forward-looking assumptions on expected growth, employment, inflation, and individual projections of future interest rate policy. The table above indicates the range of expectations.

Take-Away

Higher interest rates can weigh on stocks as companies that rely on borrowing may find their cost of capital has increased. The risk of inflation also weighs on the markets. Additionally, investors find that alternative investments that pay a known yield may, at some point, be preferred to equities. For these reasons, higher interest rates are of concern to the stock market investor. However, an unhealthy, highly inflationary economy also comes at a cost to the economy, businesses, and households.

The next FOMC meeting is also a two-day meeting that takes place July 26-27. If the pace of employment and overall economic activity is little changed, the Federal Reserve is expected to again raise interest rates.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/pressreleases.htm

Don’t Fear the Rate Hike

Posted on by cpatches
Image Credit: Samer Daboul (Pexels)

Historically, Tightening Cycles Have Not Caused Long-Lasting Market Damage

The Fed does not plan on having a tight monetary policy, just a less easy one.

On March 16, 2022, the FOMC Committee announced their intention to target a fed funds rate that would be 0.25% higher than it had been. It was the first increase since December 2018, and the hike more than doubled this key interest rate. Fed Chair Powell made it clear it would not be the Committee’s last.

Less than two months later, on May 4, the Fed adjusted the overnight target by an additional 0.50%. This was the largest increase since the year 2000.   But they were just getting started. They suspected they had fallen behind in their mandate of keeping inflation down. Stable prices generally mean balancing supply and demand, and since the Fed couldn’t do much to raise the consumable supply, they acted to dampen demand. They made money more expensive. In mid-June, the Fed hiked by 0.75%, in late July it pushed them up by 0.75% again, and that was the last time the FOMC met.

The next meeting will be held September 20-21st. The perceived guidance is that they will raise rates again by a similar amount as they did in June and July.

Tightening Cycles

The current tightening cycle is a concern for those that fear that it may lower asset prices and lower business activity. The concerns are warranted as tightening cycles are designed to do exactly that, tame prices and slow economic growth. It’s tough medicine but is supposed to provide for better economic health long term.

Over the past 30 years, the Fed has convened four recognized tightening cycles – periods when it increased the federal funds rate multiple times.

Source: Federal Reserve

Over three decades, the median number of rate hikes per period is eight, and the median time frame is 18 months (from first to last). How has the economy and markets fared through this recent history? Only two of the periods, the one ending in 2000 and then in 2006, were associated with a recession. In all four cases, the market retreated at first.

If one uses GDP as a measuring stick for an economy that is either growing or receding, then the U.S. was in a recessionary economy for a calendar quarter before the initial 0.25% hike. So the tightening may not put us into a recession, but it does have the potential to retard growth further for a  deeper recession.

Market Performance

Markets have traded lower in the months following the start of a tightening cycle, but in each of the periods defined above, they have ended higher one year later. It would seem that the market fear of what slower growth would do for companies and stock prices were front-loaded; those fears then gave way to buying as expectations became better defined.

Source: Koyfin

For the tightening cycle that began in 1994, a year after the Fed first took aim at the economy, the S&P 500 Index had already bounced off its low and climbed rapidly to end the 12 months with a positive 2.41% return. At it’s worst, the index had given up 6.50%.

Source: Koyfin

Four months after the tightening cycle began in 1999, the market began marching higher and crossed the breakeven point three times. The first time in August, just 45 days into the cycle, and the last one in May of 2000. For the 12-month period an investor in the index would have gained 5.97%.

Source: Koyfin

In 2004 the tightening cycle again began on June 30. Stock movement over the 12 months that followed are very similar as 1999. For investors that held for five months, (assuming their holdings approximated this benchmark) they were treated with returns of 4.43% 12 months later.    

Source: Koyfin

The most recent tightening cycle was seven years ago and began in December. Those invested in securities in 2015 that followed the overall stock market quickly broke even, and for those that held, they were up 10.81% a year later.

On average over the four periods the S&P 500 returned better than 6% after the Fed began a prolonged tightening cycle. The median drawdown is observed to be 9% in the first 49 days following the Fed’s first rate hike. For those that were invested in stocks that were more closely correlated to other indices, their experience was different.

Other Indices (Small Cap, Value, Growth)

Source: Bloomberg

The best average, although it did have a negative return in one of the periods, is the performance of the small cap Russell 2000 index. Investors in small cap stocks would have earned almost twice as much (11.30%) as those invested in the S&P 500 Large cap, almost three times as much earnings as those invested in the Russell 1000 Value stocks, and far more consistent and more than three times the Russell 1000 Growth index.

Take Away

This is not the first time the Federal Reserve has raised rates and implemented a tighter monetary policy. In the past it has not meant doom for the economy. In fact, the policy shift is intended to preserve a healthy economy before it begins causing larger problems for those that depend on jobs and stable prices along with a orderly banking system.

The most recent tightening cycle began six months ago. If history is an indicator, it may last another year, during that time stocks will rebound to a level higher than they were in March when the cycle began. While there are no guarantees that history will accurately point to the future, it helps to know what happened the last four times. Investors may also look to increase their allocation into small cap stocks as they have by far outpaced other indices.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=PRATES

https://www.forbes.com/advisor/investing/fed-funds-rate-history/

https://www.putnam.com/advisor/content/perspectives/

How Much More Will Your Paycheck be When Tax Brackets Adjust for Inflation?

Posted on by cpatches
Image Credit: Chris Potter (Flickr)

Increased Take Home Pay in 2023 Thanks to the IRS (and Inflation)

If two negatives make a positive, what do you get when you cross inflation with the IRS?

In addition to receiving much higher COLA increases on Social Security payments, and earning an interest rate in excess of 9% on US Savings Bonds, those making an income in 2023 are likely to see more take-home pay. This should happen whether or not they get a raise. An IRS calculation devised to prevent bracket creep is to thank for this. While high inflation is destructive, at least there are a few things that are put in place that will automatically adjust and help ease the pain.

The adjustment to tax brackets typically has had a minimal impact on workers paychecks. But the tax formulas that are law and the persistent inflation through 2022 point to significant impact on workers 2023 tax bill. Next year when income tax thresholds and the standard deductions are raised, if all else is unchanged, there will be more money in the income earners’ pockets, and less going to the government.

How Much More?

According to an accounting professor at Northern Illinois University named Jim Young, a single taxpayer with $100,000 in adjusted gross income in 2023 could experience a tax savings of about $500, or $42 each month.

Contribution maximums are also expected to be raised where tax-advantaged savings for retirement could also help reduce tax burdens in the coming years. Estate and gift tax thresholds would also automatically be increased by as much as $2 million more for a couple.

The IRS makes the adjustments based on formulas and inflation data spelled out in the tax code. This is different than the headline CPI-U which is most often reported.  

The inflation measure used for the tax and contribution adjustments is the Chained Consumer Price Index (C-CPI-U), which takes into account the substitutions customers make when costs rise. The average of the chained CPI from September 2021 through August 2022 is used to calculate the 2023 adjustments, which the IRS will announce next month. These ultimately affect tax returns for the 2023 tax year filed in early 2024.

Price increases eroding purchasing power are running at the most rampant pace in forty years. Based on the current average of the C-CPI-U, here are estimates on what to expect, according to the American Enterprise Institute:

Tax levels and other tax bracket thresholds and breakpoints will increase by around 7% over 2022. The 2022 increase over 2021 was around 3%, which was the largest percentage increase in four years. For the tax year 2023, income earners will see the breakpoints moved by the most in 35 years.

The top federal income tax threshold in 2023 is expected to rise by nearly $50,000 next year for married couples, and that 37% rate will apply to income above $693,750. For individuals, the top tax bracket will start at $578,125.

The standard deduction for married couples is expected to be $27,700 for 2023, up from $25,900 this year, and $13,850 for individuals, up from $12,950. This is the amount that those who do not itemize deductions can reduce their W-2 federal income by before being subject to income tax.

The federal estate tax exclusion amount, what a person can protect from estate taxes, is $12.06 million this year. That’s expected to rise to $12.92 million by 2023, meaning a married couple can shield nearly $26 million from estate taxes.

The annual tax-free gift limit is expected to rise from $16,000 this year to $17,000 by 2023.

The maximum contribution amount for an individual retirement account is expected to jump to $6,500 for 2023, up from $6,000, where it has been since 2019. The maximum contribution allowed for a flexible health account is expected to increase to $3,050 in 2023, up from $2,850 this year.

The maximum contribution amount for a 401(k) or similar workplace retirement plan is governed by yet another formula that uses September inflation data. It is estimated that the contribution limit will increase to $22,500 in 2023 from $20,500 this year and the catch-contribution amount for those age 50 or more will rise from $6,500 to at least $7,500.

The child tax credit under current law is $2,000 per child is not adjusted for inflation. But the additional child tax credit, which is refundable and available even to taxpayers that have no tax liability, is adjusted for inflation. It is expected to increase from $1,500 to $1,600 in 2023.

For those that look forward to capping out payments to Social Security, there is bad news. This has also increased. According to the 2022 Social Security Trustees Report, the wage base tax rate is projected to increase 5.5% from $147,000 to $155,100 in 2023.

Costs are rising, but so are deductions. It’s improbable that the reduced taxes will offset skyrocketing inflation, but at least there is one financial category that is helped by the increases.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2022

https://www.wsj.com/articles/one-upside-to-high-inflation-lower-tax-bills-11663174727?mod=livecoverage_web

https://www.spamchronicles.com/high-inflation-brings-changes-to-your-tax-bill/

The Markets Still Don’t Understand How the Current Tightening Cycle is Different

Posted on by cpatches
Source: Federal Reserve (Flickr)

The Hows and Whys of a Tightening Federal Reserve

The Federal Reserve (the Fed) will be holding a two-day Federal Open Market Committee (FOMC) meeting next week that ends on September 21. After the FOMC meeting, it is the current practice for the Fed to announce what the target Fed Funds range will be. That is, make the public aware of what overnight bank loan rate the Federal Reserve will work to maintain through open market operations.

Open market operations is the Federal Reserve buying and selling securities on the open market. The purchases are restricted to debt or debt-backed securities so that interest rates are impacted. It’s through controlling interest rates that the Fed works to maintain a sound banking system, keep inflation under control, and help maximize employment. Purchasing securities through its account puts money into the economy, which lowers rates and helps stimulate economic activity. Selling securities takes cash out of circulation. This tightens money’s availability and can also be accomplished by letting the financial instrument mature and then not replacing them with an equal purchase.

Quantitative Easing

If the Federal Reserve hadn’t put money into the economy, they’d have nothing to sell or allow to mature (roll-off). With this in mind, the natural position of the Federal Reserve Bank is stimulative.

Currently, the Fed owns about a third of the U.S.Treasury and mortgage-backed-securities (MBS) that have been issued and are still outstanding. Much of these holdings are a result of its emergency asset-buying to prop up the U.S. economy during the Covid-19 efforts.

Two years of quantitative easing (QE) doubled the central bank’s holdings to $9 trillion. This amount approximates 40% of all the goods and services produced in the U.S. in a year (GDP). By putting so much money in the economy, the cost of the money went down (interest rates), and the excess money, without much of an increase in how many stocks, bonds, or houses there are, made it easier for people to bid prices up for investible assets. For non-investments, the combination of easy money while lockdowns slowed production became a recipe for inflation.

Inflation

Inflation is now a concern for the average household. The Fed, which is supposed to keep inflation slow and steady, needs to act, so they are changing the current mix. It is making these changes by taking out a key inflation ingredient, easy money. This same easy money has been a contributor to the ever-increasing market prices for stocks, bonds, and real estate.

The overnight lending rate the Fed is likely to alter next week is the policy that will create headlines. These headlines may cause kneejerk market reactions that are often short-lived. It is the extra trillions being methodically removed from the economy that will have a longer-term impact on markets. These don’t have much impact on overnight rates, their maturities average much longer, so they impact longer rates, and of course spendable and investible cash in circulation.

Quantitative Tightening

The central bank has only just started to shrink its holdings by letting no more than $30 billion of Treasuries and $17.5 billion of MBS, roll off (cash removed from circulation). They did this in July and again in August. The Fed then has plans to double the amount rolling off this month (most Treasuries mature on the 15th  and month-end).

This pace is more aggressive than last time the Fed experimented with shrinking its balance sheet.

Will this lower the value of stocks, crash the economy, and make our homes worth the same as 2019? A lot depends on market expectations, which the Fed also helps control. If the markets, which knows the money that was quickly put in over two years, is now coming back out at a measured pace, and trusts the Fed to not hit the brake pedal too hard, the means exist to succeed without being overly disruptive. If instead the forward-looking stock market believes it sees disaster, an outcome that feels like a disaster increases in likelihood. For bonds, if the Fed does it correctly, rates will rise, which makes bonds cheaper. You’d rather not hold a bond that has gotten cheaper for the same reason that you don’t want to hold a stock that has gotten cheaper. However, buying a cheaper bond means you earn a higher interest rate. This is attractive to conservative investors but also serves as an improved alternative for those deciding to invest in stocks or bonds.

Houses are regional, don’t trade on an exchange and unlike securities, are each unique. They are often purchased with a long-term mortgage. Higher interest rates increase payment costs on the same amount of principal. In order to keep those payments affordable, home purchasers may demand a lower price, thereby causing real estate values to decline.

Take Away

The Fed has told us to expect tightening. They were honest when they promised to ease more than two years ago; there is no reason not to plan for higher rates and tighter money. The overnight rate increases get most of the attention. Further, out on the yield curve, the way quantitative tightening plays out depends on trust in the Fed and a lot of currently unknowns.

Paul Hoffman

Managing Editor, Channelchek

Source

https://www.federalreserve.gov/

The Fed Gets Inflation Tips from Cathie Wood

Posted on by cpatches
Image Credit: Meghan Marron (Pexels)

Ark Invest’s Cathie Wood Finds the Federal Reserve Quixotic

On Wall Street, staying with the herd guarantees average gains or losses. Wandering far from the herd adds two more possibilities. You may still have average performance, you may exceed the averages, or you may get slaughtered. ARK Invest’s Cathie Wood likes to explore her own field in which to graze, far from the herd. This preference shows in her funds performance. At times her returns have far exceeded competing hedge funds, and at other times they fall well below the pack.

In October of 2021, before Fed Chairman Powell changed his thinking that inflation may not be transitory, the renowned hedge fund manager, and market guru, Cathie Wood began sounding alarm bells about her fear of deflationary pressures. At the same time, she warned of job losses due to displacement as technology would reduce costs and the need for the current skill sets in the labor force.

For months renowned investor Cathie Wood has said that the Federal Reserve should stop raising interest rates, that the economy is seeing deflation rather than inflation, and that it is in a recession.

Even as others in the”transitory” camp have come more in line with the official position of the Fed on inflation, she has remained steadfast to her idea that new technology will solve supply issues. Supply is an important inflation input, and that innovation may oversupply to a point where the economy may struggle with falling prices.

This week she tweeted a few reasons for her forecast and shared her thoughts on Jerome Powell’s address at the Jackson Hole Economic Symposium.

Her view is that the Fed has overshot the target. Wood, who was already working on Wall Street during the high inflation 1970’s, tweeted her reasons for this belief. High on her list is the price of gold (expressed in dollars) which she says is one of the best inflation gauges. Gold, she tweeted,  “peaked more than two years ago.”

She also reminded followers of the price movements of other commodities, all down. These include lumber’s price decrease of 60%, iron ore 60%, oil 35%, and copper 30%. Much closer to final consumer prices, she highlighted that retailers are flush with inventories that don’t match the selling season. They’re discounting to clear shelves which could result in a deflation print in one of the more popular inflation gauges.

The Fed chairman who last fought inflation with unblinking resolve is Paul Volcker. Ms. Wood reminded her Twitter followers that the inflation he was battling had been “brewing and building for 15 years.”  In comparison, she said inflation under Jay Powell’s watch is only 15 months old and Covid-related.  She thinks the current Fed Chair has gone too far, and “I wouldn’t be surprised to see a significant policy pivot over the next three to six months,” Wood said.

A Quixotic Fed?

Powell and his colleagues are looking at the wrong data, Wood tweeted. “The Fed is basing monetary policy decisions on backward indicators: employment and core inflation,” she tweeted.  “Inflation is turning into deflation,” she said in another tweet.

Wood said, comparing the two Fed chairpersons, Powell invoked Volcker’s name four times in the Jackson Hole speech.  Her tweets explained inflation was much higher in Volker’s era.  “Until Volker took over [of the Fed] In 1979, 15 years after the start of the Vietnam War and the Great Society, did the Fed launch a decisive attack on inflation,” Wood detailed.

“Conversely, in the face of two-year supply-related inflationary shocks, Powell is using Volker’s sledgehammer and, I believe, is making a mistake.”

Take Away

Without different opinions and different investment holding periods, there would be no market. We’d all speculate on the same things, and they’d continue upward until the last dollar was invested.

Ark Invest’s flagship Arc Innovation ETF (arkk) has fallen 55% this year, more than double the fall-off of the indexes. When discussing current performance Wood has defended her strategy by reminding others that she has an investment horizon of five years. As of Sept. 7, Arc Innovation’s five-year annualized return was 5.81%.

Cathie Wood has continued an almost year-long campaign warning of deflation and saying the Federal Reserve should stop raising interest rates, and that the economy is in a recession. If she is right and has selected the investments that benefit from being correct, then those invested in her funds will be glad they placed some of their investment funds away from the herd.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://twitter.com/CathieDWood/status/1567648675635073025

www.koyfin.com

What Powell is Doing About this Vexing Inflation Contributor

Posted on by cpatches
Image Credit: IMF (Flickr)

Fed Chairman Powell Shows His Steady Hand and Firm Conviction at Monetary Conference

In what is his last scheduled public appearance before the post-FOMC statement expected on Sept. 21, Fed Chairman Powell did not say anything that would change expectations of another 75bp Fed Funds rate hike. He instead emphasized the Fed’s commitment to reduce inflation and believes it can be done and at the same time avoid “very high social costs.” 

“It is very much our view, and my view, that we need to act now forthrightly, strongly, as we have been doing, and we need to keep at it until the job is done,”  Powell said Thursday (Sept. 8) at the 40th annual Monetary Conference held virtually by the Cato Institute.

The discussion was held after it was known that the Eurozone Central Bank had just raised rates by 75bp. Powell’s talk and the interest rate hike overseas didn’t upset U.S. markets as U.S. Jobless claims had been reported earlier and showed a very strong labor market which helped demonstrate that the Fed’s actions to return inflation to a more acceptable level are not severely hurting business.

The Federal Reserve Chairman continued to reiterate what he has been saying, that the U.S. central bank is focused on bringing down high inflation to prevent it from becoming entrenched as it did in the 1970s. The core theme, most recently heard at the Jackson Hole Economic Symposium, is that he is resolved to return inflation to the Fed’s 2% target.

Mr. Powell said it is critical to prevent households and businesses from ongoing expectations that inflation will rise. He said this is a key lesson taken from the persistent inflation of the 1970s. “The public had really come to think of higher inflation as the norm and to expect it to continue, and that’s what made it so hard to get inflation down in that case,” Powell said. The takeaway for policymakers, he added, is that “the longer inflation remains well above target, the greater the risk the public does begin to see higher inflation as the norm, and that has the capacity to really raise the costs of getting inflation down.”

Speaking the day before at the Economic Outlook and Monetary Policy at The Clearing House and Bank Policy Institute Annual Conference, Fed Vice Chairwoman Lael Brainard, didn’t express a preference on the size of the next increase but underscored the need for rates to rise and stay at levels that would slow economic activity. “We are in this for as long as it takes to get inflation down,” she said.

Fed officials have raised rates this year at the most rapid pace since the early 1980s. The federal funds rate, the percentage banks charge each other for overnight borrowing, rose from near zero in March to a range between 2.25% and 2.5% in July, which is where it sits today.

Take Away

The Fed’s two mandates are to keep inflation at bay and to make sure there are adequate jobs in the U.S. The lessons of the past indicate that expectations of inflation are inflationary themselves. The Fed Chairman and Fed Vice Chairwoman would undermine their goals if they did not talk tough on inflation. With the economy not having sunk into a deep recession, and joblessness at acceptable levels, their actions are likely to match their tough talk.

The stock market typically behaves well when confident that the Fed is fighting inflation and has a steady grasp of what too far is. Overly tight money would dampen business growth.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/calendar.htm

https://www.cato.org/events/40th-annual-monetary-conference

https://www.nytimes.com/live/2022/09/08/business/ecb-meeting-inflation-interest-rates

https://www.reuters.com/markets/us/us-weekly-jobless-claims-fall-three-month-low-2022-09-08/

Will the Dollar and Securities Markets Sink When the War Ends?

Posted on by cpatches
Image Credit: Andre Furtado

The Story of War and Peace in the Currency Markets

There is a story of war and peace in the contemporary currency markets. It has a main plot and many subplots. As yet, the story is without end. That may come sooner than many now expect.

The narrator today has a more challenging job than the teller of the story about neutral, Entente, and Central Power currencies during World War I. (See Brown, Brendan “Monetary Chaos in Europe” chapter 2 [Routledge, 2011].)

Today’s Russia war (whether the military conflict in Ukraine or the EU/US-Russia economic war) is not so all-pervasive in global economic and monetary affairs, though it is doubtless prominent. The monetary setting of the story today is much more nuanced than in World War I when the prevailing expectation was that peace would mark the start of a journey where key currencies eventually returned to their prewar gold parities.

In the 1914–18 conflict, any sudden news of a possible end to the conflict—as with the peace notes of President Woodrow Wilson in December 1916—would cause a sharp fall of the neutral currencies (Swiss franc, Dutch guilder, Spanish peseta), a big rise in the German mark and Austrian-Hungarian crown, and lesser rises in sterling and the French franc. Today, in principle, a sudden emergence of peace diplomacy would most plausibly send the euro and British pound higher on the one hand and the Canadian dollar, US dollar, and Swiss franc lower on the other hand.

Mutual exhaustion and military stalemate are a combination from which surprise diplomatic moves to end war can emerge. These circumstances apply today.

Ukraine is falling into an economic abyss—much of its infrastructure reportedly destroyed and its government is resorting to the money printing press to pay its soldiers (see Kenneth Rogoff et al., “Macroeconomic Policies for Wartime Ukraine,” Center for Economic and Policy Research, August 12, 2022). General economic aid from Western donors (as against military aid) is running far short of promises. All these pictures of Russian munitions stores on fire may or may not have excited some potential donors, but they have not heralded any breakthrough.

The human toll—both amongst military personnel and civilians—fans Moscow propaganda that the US and UK are willing to conduct their proxy war against Russia down to the life of the last Ukrainian soldier.

Meanwhile there are these presumably leaked stories in the Washington Post about how President Volodymyr Zelensky betrayed the Ukrainian people by not sharing with them in late 2021 and early 2022 the US intelligence alerts about a looming Russian invasion. According to the stories, many Ukrainians resent that they were not warned by their government and do not accept its shocking excuses (for example, to prevent a flight of capital out of the country).

Is all this preparing ground for a possible power shift in Kiev that might favor an early diplomatic solution even in time for President Joe Biden to claim credit ahead of the midterms? Western Europe will be spared some pain this winter if the initial ceasefire agreement includes a provision that Moscow desist from turning off the gas pipelines.

The purpose here is not to predict the war’s outcome but to describe a peace scenario that is within the mainstream and to map out how the rising likelihood of its realization would influence currency markets.

The main channel of influence on currencies would be the course of the EU/US-Russia economic war. A ceasefire would excite expectations of big relief to the natural gas shortage in Western Europe.

Prices there for natural gas would plunge. In turn, that would lift consumer and business spirits, now depressed by feared astronomic gas bills and even gas rationing this winter. Massive programs to relieve fuel poverty, financed by monetary inflation, would stop in their tracks. The European Central Bank (ECB) could move resolutely to tighten monetary conditions as the depression fears faded.

We could well imagine that the peace scenario would mean the European economies in 2023 would rebound from a winter downturn. That would coincide with the US economy sinking into recession as the “Powell disinflation” works its way through—including continued bubble bursting in the tech space and residential construction sector plus a possible private equity bust.

A big rise of the euro under the peace scenario, though likely, is not a slam-dunk proposition. Russia might delay turning the gas pipelines back on until there is an assurance about its central bank’s frozen deposits in Western Europe. There has been chatter from the top of the Organisation for Economic Co-operation and Development (OECD) down that a reparations commission would sequester these.

More broadly, it could be that most European households are not cutting back their spending to the extent assumed in the consensus economic forecasts. Many individuals may have never believed that the high natural gas prices would persist beyond this winter. Then they faced, in effect, a transitory rather than permanent tax rise. Economic theory suggests that such transitory taxes, paid in this case to North American natural gas producers, have much less impact than permanent ones on spending.

There are still the deep ailments of the euro. How can the ECB ever normalize monetary conditions when so much of the monetary base is backed by loans and credits to weak sovereigns and banks (see Brendan Brown, “ECB’s Long Journey into Currency Collapse Just Got a Lot Shorter,” Mises Wire, July 23, 2022)?

In principle, the US dollar, and even more so the Canadian dollar, would lose from peace as they have gained from war. Both have obtained fuel from the boom in their issuing country’s energy sector. In neither country has there been aggregate real income loss due to the economic war—in fact, there has been a gain in the case of Canada. A further positive for the US dollar has been the boom in the US armaments sector—and this should continue beyond a ceasefire.

Peace will not deflect Europe from seeking to diversify its energy supplies away from Russia and to North American gas and to renewables. But we can imagine that in the long-run, Germany could have a comparative advantage in the renewable space; and North America could lose potential sales outside Europe to Russian gas at discounted prices. Russia is widely expected to prioritize a vamped-up construction program for LNG (liquid natural gas) terminals. These will enable the export of its natural gas to world markets.

Bottom line: peace is likely to be a negative for the US dollar. But transcending this influence is the huge issue of how and when US monetary inflation regains virulence.

About the Author:

Brendan Brown is a founding partner of Macro Hedge Advisors (www.macrohedgeadvisors.com) and senior fellow at Hudson Institute. He is an international monetary and financial economist, consultant, and author, his roles have included Head of Economic Research at Mitsubishi UFJ Financial Group and is also a Senior Fellow of the Mises Institute. Brendan authored Europe’s Century of Crises under Dollar Hegemony: A Dialogue on the Global Tyranny of Unsound Money with Philippe Simonnot.

The article was republished with permission from The Mises Institute. The original version can be found here.

Powell Says He’s Resolved to Conquer the Mountain of Inflation

Posted on by Admin 



Image Credit: Maureen (Flickr)


Powell Answered the Market’s Three Most Pressing Questions at Jackson Hole Symposium

Federal Reserve Chair Jerome Powell kept his address at Jackson Hole brief and focused. He also gave an intentionally direct message about the current economic environment and his resolve to succeed in changing it.

Powell told his audience, both attendees of the symposium and the broadcast audience, that the monetary policy setting arm of the Fed (FOMC) has as its highest focus to bring inflation back down to its 2% target. Aware that he was speaking to a world audience, he made clear that price stability in the U.S. is the responsibility of the Federal Reserve – and without stable prices, the economy is on shaky ground. He connected low inflation with achieving a sustained period of strong labor markets. Which, alongside inflation, are the mandates of the U.S. central bank. Powell said, “The burdens of high inflation fall heaviest on those who are least able to bear them.”


Is the Fed Okay with a Recession Level Contraction?

He offered that restoring price stability won’t happen in weeks or even months; because it takes time to bring demand and supply into better balance. Is the Fed okay with a recession-level contraction? Powell said, “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions.” Powell then explained, “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.” The Fed Chair said he believes that failing to calm inflation “would mean far greater pain.”


What is the Current State of the U.S. Economy?

Powell believes the economy is showing strong underlying momentum, despite mixed economic numbers. As an example, he said, “The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers.” He added, “Inflation is running well above 2 percent, and high inflation has continued to spread through the economy.” He recognized that July showed an improvement in inflation but said a one-month improvement  “falls far short of what the Committee will need to see.”


What is the Fed Doing to Achieve Balance?

The Fed Chair said they are moving policy to a level that will be restrictive enough to return inflation to 2%. He told listeners that after the last FOMC meeting, they raised the target range for the federal funds rate to 2.25 – 2.5 percent. Powell then offered that with current inflation above 2%, they won’t stop or pause. The estimate is the overnight lending rate, once 2% increases in prices are achieved, is likely to be near the current Fed Funds rate. He recognized that July’s second 75bp increase was large, and under the circumstances, may occur again after the September meeting.

The Fed expects to maintain a restrictive policy stance for some time. He discussed what has happened when the Fed has prematurely eased policy. He offered the FOMC participants’ most recent individual projections from June estimated Fed Funds would run slightly below 4 percent through the end of 2023.

The public’s expectations about future inflation play a role in setting inflation over time. He recognizes that an inflation mentality has not set in, he said, “ But that is not grounds for complacency, with inflation having run well above our goal for some time.”

Powell seemed to want to stress to the markets (bond, stock, real estate), that the Fed plans to do whatever it takes, and it will take a lot. He said he has learned from the mistakes of past Fed chairman, he is being guided by them, and repeatedly expressed his strong resolve to meet the 2% target.

Paul Hoffman

Managing Editor, Channelchek

Suggested Content



What is the Jackson Hole Symposium and Why it’s Important to Investors?

The Soft Landing Challenge, Fed Chairman Makes No Promises




Is Michael Burry Frustrated that the Market Hasn’t Yet Crashed?

Which Stocks go up When Global Currencies Weaken vs US Dollar?


Source

https://www.youtube.com/KansasCityFed

Stay up to date. Follow us:

 

What Signs Will Investors Get from Powell at Jackson Hole

Posted on by Admin 



Image Credit: Steve Jurvetson (Flickr)


What is the Jackson Hole Symposium and Why it’s Important to Investors?

With almost a month to go before the next FOMC meeting, investors have set their focus on the Jackson Hole Economic Symposium – the conference organized each year by the Kansas City Federal Reserve Bank. Last
year’s symposium (held online for attendees) allowed the Fed Chair to recap the challenges of the previous 12 months of pandemic management. One Powell utterance that was mostly overlooked last year was his comment on inflation when he pointed out that demand was outstripping pandemic-reduced supply. He said it was a big factor in why inflation was running ahead of the Fed’s 2% target. One year later, inflation is likely to be the most discussed topic, and market participants and others interested in the economy will be listening intently to how strongly the U.S. Central Bank will need to squelch growth to bring damaging inflation down.


About the Jackson Hole Event

The Kansas City Fed has been hosting the annual conference to discuss the economy since 1982 at a lodge in Grand Teton National Park. The attendees are central bankers from around the world, economists from the 12 Federal Reserve Districts, academics, influential economic leaders, policymakers, and journalists.


Image: Jackson Hole Symposium attendance (Kansas City Federal Reserve)

Each year there is a theme. For example, “Guided by
the Stars” in 2018 set the tone for the year’s whitepapers and speeches the event is known for. Powell’s 2018 address is considered his most memorable. It outlined how he thinks about critical but unmeasurable variables like the natural rate of interest (R-star) and the natural rate of unemployment (U-star). For 2022 the theme is “Reassessing Constraints on the Economy
and Policy.” To be sure, the world will be listening – so far this decade, Central Banks have seemed to push the barriers of previously believed boundaries and constraints on policy. There will also be a number of whitepapers made public on the subject; these will be released Thursday evening. Powell’s speaking slot is first thing Friday (10 am EDT)

The presentations and discussions are not broadcast (except for Powell’s speech this year), but all of the proceedings in the room are on the record, and economic journalists are on hand to report what they hear. The Kansas City Fed publishes the papers on its website.


Powell’s Words

One of the most powerful market-moving things a Fed Chair can do is talk. Every word of his speech will be scrutinized; they know this, so they choose their words wisely. Traditionally, the Fed chair uses the Jackson Hole speech to deliver a particularly important and long-range message, similar to a president’s State of the Union.

It is highly unlikely he will give any guidance as to what he is doing next month. Instead, he’ll be recognizing paths and cultivating an understanding of changes in the economic climate and policies to foster desired long-term results.  


Is it all Business?

In the early 1980s, the Kansas City Fed leaders learned that the best way to ensure Fed chairman Paul Volcker would accept an invitation was to locate the event somewhere with good fly fishing in late August. Jackson Hole was it!

It also helps that the late summer ski resort setting is gorgeous. The weather is usually great, and the Kansas City Fed has done a commendable job cultivating compelling topics, papers, and guest lists over the years.

The eventgoers are not surrounded by luxury. Rather, it’s at a lodge in a national park that remains open to the public. It features a big grizzly bear trophy in the lobby. The rooms are rustic.

In and around the conference, it is common to see powerful economic policymakers from around the world wandering the hotel lobby, along with American tourists who drove in an RV or a group of motorcycles.

Some symposium attendees adopt Western fashion, wearing cowboy hats, boots, and pearl snap shirts. Others find more traditional business casual more their flavor. After the second day of economic meetings, attendees usually go to a Friday dinner with Western-themed entertainment, such as a horse whisperer.


Take Away

Four decades after the first Jackson Hole Economic Symposium, it is an important event for those in the meetings and an important event for those with a stake in the U.S. economy. History is made at these meetings as subtle shifts have a big impact on the future wealth of the nation. The mountain resort lends itself to a relaxed feel. Behind closed doors at the symposium itself, the small amount of attendees is closer than at many economic conferences.

Beginning at 10 am EDT tomorrow, the markets will have their answer as to what the Fed Chair will say. If it is in line with his more recent comments, he will place inflation as a priority and word it in a way where it is understood but not feared by those with business interests.

Paul Hoffman

Managing Editor, Channelchek

Suggested Content



The Fed Chairman is Less Likely to Box Himself in With Specific Promises

The Soft Landing Challenge, Fed Chairman Makes No Promises




Bond Market Understanding is Again Critical for Stock Investors

Fed Chairman Addresses Inflation, Tapering, and Employment at Jackson Hole Summit


Sources

https://www.kansascityfed.org/research/jackson-hole-economic-symposium/about-jackson-hole-economic-symposium/

https://www.cnbctv18.com/economy/jackson-hole-symposium-2022-all-eyes-on-us-fed-chair-jerome-powell-expectations-explained-14583021.htm

Stay up to date. Follow us:

 

The More Impactful Fed Moves May Not Make Headline News

Posted on by Admin 



Image Credit: Stuart Richards (Flickr)


Is Quantitative Tightening Impacting the Economy on the QT?

The Fed has begun to reduce the trillions it has added to its balance
sheet. With each dollar it added to the economy over the past two years, there was a new dollar available to provide capital for growth and investment. Or a new dollar to help hold borrowing costs down. Quantitative
tightening (QT) is out of the spotlight relative to overnight bank lending rates. Yet, QT could have a much greater economic impact on all markets, from real estate to stocks, and more directly fixed income.

There is less understanding of QT. The Federal Reserve’s effort to shrink its balance sheet after buying trillions in bonds is somewhat complicated and less visible. But, although QT is on the quieter side of what is shaping tomorrow’s economy, investors need to know how shrinking the balance sheet, the other tightening, impacts investments.

The Fed stopped its bond purchases in May. That is to say, they stopped buying bonds that injected money into the system. This is referred to as quantitative easing (QE).

In June, after a period of tapering its purchases, the central bank began QT> Then it announced it would partially unwind roughly $4.5 trillion that had previously been purchased. The Fed officially said that it would start by letting up to $30 billion in US treasuries and $17.5 billion in mortgage-backed securities (MBS) mature out of its holdings (balance sheet). During the previous months, it would have reinvested the maturing amount and even added to the purchases.  The announcement was, beginning in September, it’s shrinking the balance sheet could increase to $60 billion maturing bonds not rolled in treasuries and 35 billion not reinvested in MBS securities. Fed Chairman Jerome Powell shared a plan lasting 2½ years, which implies the Fed’s $9 trillion balance sheet could shrink by as much as $2.5 trillion. Roughly half of what was added to support the economy during the pandemic.


Lack of Awareness

The financial news likes to keep it simple. And quantitative tightening isn’t simple, so its impact isn’t reported to the extent that an overnight increase, which is easier to understand, is presented. With QT, there is no prior hype asking “what is the Fed going to do?” and there is little certainty to what they have done. It just happens, no fanfare, no commentary.

Historically, this kind of tightening has been attempted only once before, and it was derailed. The transparent Fed is ridiculed and criticized when it removes economic stimulus. So there may not be a strong overall belief that the Fed will actually remove the trillions of extra money now floating around and creating economic opportunity by inflating asset prices.   Also, overnight rate increases are much easier for economists to model and news for mass public consumption to report on.

So, the news of QT is underreported and ignored. What is being reported is a strong doubt that the Fed is following through on its balance-sheet tightening plan, particularly with MBS. For those that have looked at the Federal Reserve’s balance sheet, the doubt is not without cause.

Barron’s spoke with a senior trader on the Fed’s open markets desk. This is what the well-respected investment publication was told. The Fed is conducting QT as it has said it would. The trader said people are confused because it looks like the Fed’s MBS holdings aren’t decreasing and even may be increasing.

The trader told Barrons that the saw-toothed pattern in the Fed’s MBS holdings is the result of accounting issues. First, there is a gap between when MBS purchases settle and when holders of MBS receive payments. Second, the Fed has a three-month window for settling MBS purchases. The Fed is the largest single investor in the MBS market, the Fed has the option of delaying settlements if it thinks that will create a better functioning market.

In effect, this means MBS purchased by the Fed, as it does when it reinvests pay downs, could just be showing up. QE ended, but if there are pay downs in excess of the Feds goal of runoff, the excess is reinvested. The settlement dates differ and cause the appearance of a balance sheet that may have grown. This isn’t the case, and investors need to know that longer-term interest rates are being tightened.

The Fed senior trader warned something is apt to break, not unlike what happened the last time the Fed tried QT, and chaos in the repo market prompted an early end to the return to “normalcy.” But he was more optimistic as he said the Treasury may be more supportive in smoothing the process of reducing liquidity while not disrupting markets.


Take Away

If quantitative easing (QE) mattered, then quantitative tightening should too. It isn’t reported on as prominently as direct interest rate hikes, but the impact is the direct inverse to what allowed so much economic growth. So, the savvy investor will pay attention, which may give them an edge. For the Fed to bring inflation back to 2%, the Federal Reserve would need to shrink its balance sheet by the almost $4 to $5 trillion it increased it a short time ago. This could increase longer-term interest rates by far more than the announced increases in short-term rates.

Paul Hoffman

Managing Editor, Channelchek

Suggested Content



Powell’s Economic Soft Landing Requires More Room to Change his Mind

Bond Market Understanding is Again Critical for Stock Investors




What is the Fed’s Balance Sheet

What is Quantitative Tightening


Sources

https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

https://www.barrons.com/articles/intel-chip-stocks-to-buy-now-51660333062

https://en.wikipedia.org/wiki/Quantitative_tightening

Stay up to date. Follow us:

 

Michael Burry Uses Twitter to Offer More Proof of His Theory

Posted on by Admin 



Image(s): Wikimedia.org


Does Michael Burry Have a Problem with John Maynard Keynes?

There is no doubt that Dr. Michael J. Burry is familiar with Keynesian economics theory. Under the theory, the government should help control aggregate demand by infusing money into a weakening economy to create added demand or withdraw currency to reduce demand. But there is a caveat to this basic tenet of Keynes’ theory, and it seems Michael Burry, famous hedge fund manager at Scion Asset Management, has little patience for it.

Followers, both fans and haters, pay close attention to the tweets the Scion Asset Management founder often uses to share his thoughts. Burry’s tweets are usually deleted by him shortly after he sends to keep BOT benefactors down. So his Twitter account isn’t always the best place to see his thinking that is more than a few hours old.


What is Michael Burry is Saying

Burry’s recent tweets have indicated he believes retailers could cut prices to rid themselves of inventories caused by seasonal delivery inventory mismatches. Also, dwindling savings and soaring debt could spark a recession. He just offered more proof of his theory.

At about 4 am this morning (presumed Pacific time), Burry posted a Bloomberg chart on U.S. consumer credit use. The graph reaches back to 1991 and carries into the recent monetary policy tightening. Along with the chart, Burry tweeted, “Net consumer credit balances are rising at record rates as consumers choose violence rather than cut back on spending in the face of inflation. Remember the savings problem? No more. COVID helicopter cash taught people to spend again, and it’s addictive. Winter coming.


Source: @michaeljburry (Twitter)

When speaking of economic cycles, “winter” is often referred to as the downside of the cycle; there is death and dormancy among businesses in the winter. It’s miserable, but it leads to the spring part of the cycle with new growth.  Translating further, if the consumers continue to buy, despite having an unsustainable ability to continue at the previous pace, a more violent winter may fall upon the economy. 

The chart attached to the tweet shows the net change of consumer debt each month as recorded by the Federal Reserve. The historical average, including negative periods, is $27.5 billion.  The current monthly pace is $27.5 billion.

Burry noted in May that American consumers, faced with rising food, fuel, and housing costs, were pulling from their incomes, racking up credit-card debt, and poised to virtually exhaust their savings by the end of 2022.


What Keynesian Theory Says

Keynesian economic theory says the government should help free markets when they are faltering by injecting cash. The cash will then spur aggregate demand for goods and services. And the government should also pull money from the system to reduce demand in an overheated situation. Having a smoothing hand, in addition to the free market’s invisible hand, could lead to a more balanced outcome and a more even keel.

The theory also recognizes that if additional money is put into consumers’ hands today that it works its way into the economy quickly. The U.S. experienced this a couple of years ago with stimulus checks that began stimulating right after being announced – even before distribution. However, if money is removed from the system, spending continues at the same pace for a while as consumer spending habits don’t back off the consumption gas pedal as quickly.

Most consumers are no longer receiving benefits doled out through the pandemic and are now confronted with rampant inflation. Yet, despite worsening cash flow and higher prices, they are consuming at the same level, making up the difference by pulling from savings and increasing debt. This is right in line with what John Maynard Keynes would expect. At least at the beginning.

Keynes would also expect a turn to more conservative spending eventually, currently, consumer tapering on spending is just beginning. And based on his theory, it will be followed by a reduction in consumption.

 

Is Burry at Odds with Keynes?

The short answer is what Burry has been bringing to investors’ attention is right in line with what Keynes, in 1936,  said could be expected. Apparently, human nature related to consumption hasn’t evolved.

I am sure Dr. Burry understands that reactions when it comes to cutting back aren’t immediate. But what may frustrate him is that the markets (not the consumer) always take so long to spot what he is seeing. He has a habit of getting into trades much earlier than others. His expectations, more often than most, play out as he expects, with one exception. The exception is timing. Even in his famous “big short” of the mortgage market, he was a couple of years ahead on his credit default swap play. One can presume that he felt a good deal of pain as housing continued on its path for much longer than expected. 

 

Practical Use

The central bank has to be out ahead of the economy when the pace is heating up because taking the proverbial “punch bowl” away doesn’t cause immediate sobriety. Burry predicted consumer spending would drop as a result of tightening and believes retailers will cut prices to lessen overstocking and badly timed inventories. This would help derail inflation and put pressure on retail and other earnings by Christmas. The tweeted chart of consumer debt above shows the “party” is still raging as the government-supplied punch bowl has been removed, but people are tapering by using their limited stash. When that stash taps out, there will be an abrupt end.

Earlier this week he tweeted about the turnaround in the stock market, specifically Nasdaq. He warned that the big-tech heavy index may be 20% off its low, but history indicates that this doesn’t mean that it can’t fall dramatically as it did seven times after 2000 when the dot-com bubble burst.


Source: @BurryArchive (Twitter)

Frustration is a common theme of his tweets. Some of the frustration is a lack of patience for things like the nuances of Keynesian economics and the overall behavioral patterns of investors across many asset classes.

Burry He also has asserted the pain for investors might not end until they swear off owning tech stocks, cryptocurrencies, and non-fungible tokens (NFTs). Referring to the latest w/streetbets “meme-stock” additions AMTD (HKD) (which rose 21,000%) and Magic Empire (MEGL) (which rose 2,000%) he recently complained that market “silliness” is back after the two IPOs skyrocketed.


Source: @BurryArchive (Twitter)


Take Away

An investor can be consistently right about the future direction of individual stocks or the markets. If they perceive what is going to happen to be timed much sooner than the other players, they will miss other opportunities, or more frustrating, lose patience with the position and get out of it before it becomes profitable.

In the book about Michale Burry’s housing crisis position, it took a long time for what he was certain to happen, to become reality. He lost a lot of investors in his funds while waiting for what he believed to be inevitable, played out. Classic economic theory tells us that we should expect delays in cause and effect. As investors, we need to remind ourselves if we are long-term and willing to ride out the ups and downs to stick to the plan. Or if we are more active, we may try to take advantage of shorter moves that may be against our overall thoughts on the long-term direction.

Follow Channelchek’s Twitter account and let us know under this article your overall thoughts on the market, and favorite small-cap stocks. 

Paul Hoffman

Managing Editor, Channelchek

Suggested Content



Michael Burry is Predicting More Red

Is Michael Burry Frustrated that the Market Hasn’t Yet Crashed?




Are Consumer Price Increases Negatively Correlated to Stock Market Price Levels?

Cathie Wood’s Expectations for Inflation, Recession, Markets, China, and Jobs


Sources

https://twitter.com/BurryArchive/status/1557518533172477952/photo/1

https://twitter.com/BurryArchive/status/1557430160512524288

https://twitter.com/michaeljburry

W.
Carl Biven (1989). Who Killed John Maynard Keynes? Conflicts in The Evolution
of Economic Policy

Stay up to date. Follow us: