Unbalanced Hype in the Markets Surrounding the “Unknowable” Could be Costly
“It’s not knowable” if there will be a recession in 2023, said Fed Chair Jerome Powell recently. A month earlier, after the last change in monetary policy, he said it is easier to go too far and bring the economy back than to do too little and then have to then tame stronger inflationary pressures. The most recent CPI number shows a trend that policymakers want to see, but it likely is not a number the Fed will pivot off of. After all, for the Consumer Price Index (CPI) to rise by 6.5% YoY means that cost increases experienced by consumers are running more than three times higher than the Fed’s stated target. Of course, the rate increases have not had time to work their way into the system; they haven’t even fully worked their way into the interest rate markets.
An Alternative Way to Look at Tightening
Relatively speaking, a hypothetical decline in your investment account by 2% last month may be an improvement in performance if it had been down 3% the month before. But if your need to meet your goals is a positive 8%, then you still have a lot of work to do in order to consider yourself successful. The same for the Fed policymakers. US dollar buying power is losing ground, just not as quickly as it was. And since the inflation rate is also subject to what savers and investors call ‘the miracle of compounding’ and the jobs market is strong, the Fed has motivation and room to keep pulling money from the system and raising interest rates – the sooner, the better based on Powell’s statements.
And it may be that they are willingly driving the economy into reverse to stop service costs from rising as quickly, and bring inflationary wage increases lower. Workers, after all, have not reacted to the possibility of a recession. They still feel at ease leaving their employers at a very high pace, and the layoff rate is still near a record low. To demonstrate, the economy added 223,000 in payroll employment in December (well above the 200,000 forecast — and the unemployment rate came down to 3.5%, below the 3.7% forecast. This may not seem high compared to the gains just after the pandemic opening, but it is quite steamy.
Take Away
The financial news has been full of ‘pivot’ headlines for months. When it comes to the “unknowable,” it is important to remind oneself, as an investor, that very few things are a done deal until they happen. The big picture is the bond market has not priced itself in a way that fully reflects the Fed tightening of short-term rates. This represents difficulty for the Fed, and the Fed is looking for slower economic growth.
Throughout 2022, the big question while consumers faced increasing prices was whether the Federal Reserve would push the economy into decline. Their intent, after years of excessive stimulus, is to slow economic growth to bring inflation down. The Fed hiked interest rates seven times during 2022, its aggressive tactics caused some to worry about job losses and a recession. With an inflation rate that Powell thinks is more than three times too high, investors must consider that the Fed has different goals than investors but the same as consumers. We are all consumers, we’re not all investors.
As a final note, what the year brings is unknowable. There are always stocks going up, going down, and tracking sideways. A 2% inflation rate is easier to beat in terms of performance as an equity market investor than a 4% or 6% level. What the Fed will do, they likely don’t know for sure themselves; our job, that of investors, is to not get caught up in hype. And the markets and the media are breeding grounds for hype.
The Data Supporting Small-Caps Should Attract Money from Former Mega-Cap-Only Investors
When I see an investment statistic that reads, “in the past, this has happened 100% of the time,” I not only take note for my own portfolio consideration, I share it with my more risk-averse investment friends. It’s now mid-January, and like many investors, I have read dozens of 2023 forecasts and projections. I value the ones where the forecaster likely has skin in the game (i.e.: not many economists), and I am more highly interested in those that support forecasts with stats (ie: most economists). I came across a stat of ‘100% of the time’ from a trusted source that has skin in the game – this is certainly share-worthy.
Source
Each month Royce Investment Partners publishes an interview-style update between founder Chuck Royce and Co-CIO Frank Gannon. It’s always full of statistics and probability analysis. It never fails to be interesting and very often worthwhile. Investment decisions based on hard data from the past are less speculative, this doesn’t always make the investment a win, but it lowers the need for guessing. And if the stats are based on a large enough sample period, confidence to act overrides underlying opinion or emotions. The most recent publication from Royce Associates, LLC offers very compelling data.
The update includes a look at the stock market trends of late last year and why they’re confident small-cap stocks can achieve a positive return that could outpace larger-cap sectors. Especially for those companies whose underlying data meet criteria that they also explain.
Rear Looking View
The two were able to put the challenges for many investors last year in context by first talking about how infrequently bonds and stocks have gone down in the same year. This left 60/40 investors without anything to be happy about. Then they switched to small cap versus large cap, which they say was the third worst year for both the small-cap Russell 2000 Index, which fell 20.4%, and the Russell 1000 Index, which declined 19.1%. The third worst since each index’s inception at the end of 1978. According to the Royce update, “only two years had lower returns—and it was the same two years for both indexes—2008 during the Financial Crisis and 2002 through the worst year of the Internet Bubble.”
Forward-Looking View
As indicated above, Royce Associates believes small-cap is well positioned for positive returns and long-term comparative performance. The argument is hinged mainly on valuation but also on past behavior.
Valuation, they explain, even after last year’s sell-off, “remained near its lowest rate in 20 years compared to large-cap’s, based on our preferred valuation metric of the median last 12 months’ enterprise value to earnings before taxes (LTM EV/EBIT).” Royce recognized that accompanying the worldwide equity sell-off, many small-cap stocks were taken lower unrelated to financial fundamentals and/or operational expertise. “We have often been struck by the contrast between the more confident—albeit cautious—outlooks from the many management teams we’ve met with and the fatalistic headlines we see almost every day,” they explain.
A High Probability of Positive Small-Cap Performance Ahead? Average Subsequent Five-Year Annualized Performance for the Russell 2000 in Trailing Five-Year Return Ranges of less than 5% from 12/31/83 through 12/31/22:
Source: Royce Investment Partners (Past performance is no guarantee of future results).
Frank Gannon says, “small-cap’s historical performance patterns show that below-average longer-term return periods have been followed by those with above-average longer-term returns—and the subsequent periods have enjoyed positive returns most of the time.” Drilling down to the numbers of the market’s current state, he says, “Subsequent annualized three-year returns from three-year entry points of less than 5% have been positive 99% of the time—that is, in 75 out of 76 three-year annualized periods—averaging 16.1% since the Russell 2000s 12/31/78 inception.”
Stretching the investment period out to five years had even higher probabilities and positive outcomes. “The Russell 2000 also had positive annualized five-year returns 100% of the time—that is, in all 81 five-year periods—and averaged an impressive 14.9% following five-year periods with annualized returns of 5% or less. We think this is especially relevant now because the respective three- and five-year annualized returns for the Russell 2000 as of 12/31/22 were 3.1% and 4.1%.”
On the subject of inflation, the Royce review was also positive. “Small-cap has beaten inflation in every decade going back to the 1930s—and is the only equity class to have done so.” Details of how this and other numbers are derived can be found in the article (available here).
Take-Away
While Royce Investment Partners, a fund company that holds small-cap stocks as its specialty, is not affiliated with Channelchek, or Noble Capital Markets, the monthly and quarterly newsletter/blog is always looked forward to. New readers should be ready for numbers and details backing up their stated positions. This is something not always found in public forecasts by other investment officers or portfolio managers. It’s more longwinded than some, but this is good because sound bites are not very helpful when one investor is trying to understand the thoughts of another.
To find data on ‘less-followed’ stocks, sign- up here for Channelchek and get immediate, no-cost access to information on over 6,000 small and microcap companies.
What’s a ‘Gig’ Job? How it’s Legally Defined Affects Workers’ Rights and Protections
The “gig” economy has captured the attention of technology futurists, journalists, academics and policymakers.
“Future of work” discussions tend toward two extremes: breathless excitement at the brave new world that provides greater flexibility, mobility and entrepreneurial energy, or dire accounts of its immiserating impacts on the workers who labor beneath the gig economy’s yoke.
This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of David Weil, Visiting Senior Faculty Fellow, Ash Center for Democracy Harvard Kennedy School / Professor, Heller School for Social Policy and Management, Brandeis University.
These widely diverging views may be partly due to the many definitions of what constitutes “gig work” and the resulting difficulties in measuring its prevalence. As an academic who has studied workplace laws for decades and ran the federal agency that enforces workplace protections during the Obama administration, I know the way we define, measure and treat gig workers under the law has significant consequences for workers. That’s particularly true for those lacking leverage in the labor market.
While there are benefits for workers for this emerging model of employment, there are pitfalls as well. Confusion over the meaning and size of the gig workforce – at times the intentional work of companies with a vested economic interest – can obscure the problems gig status can have on workers’ earnings, workplace conditions and opportunities.
Defining Gig Work
Many trace the phrase “gig economy” to a 2009 essay in which editor and author Tina Brown proclaimed: “No one I know has a job anymore. They’ve got Gigs.”
Although Brown focused on professional and semiprofessional workers chasing short-term work, the term soon applied to a variety of jobs in low-paid occupations and industries. Several years later, the rapid ascent of Uber, Lyft and DoorDash led the term gig to be associated with platform and digital business models. More recently, the pandemic linked gig work to a broader set of jobs associated with high turnover, limited career prospects, volatile wages and exposure to COVID-19 uncertainties.
The imprecision of gig, therefore, connotes different things: Some uses focus on the temporary or “contingent” nature of the work, such as jobs that may be terminated at any time, usually at the discretion of the employer. Other definitions focus on the unpredictability of work in terms of earnings, scheduling, hours provided in a workweek or location. Still other depictions focus on the business structure through which work is engaged – a staffing agency, digital platform, contractor or other intermediary. Further complicating the definition of gig is whether the focus is on a worker’s primary source of income or on side work meant to supplement income.
Measuring Gig Work
These differing definitions of gig work have led to widely varying estimates of its prevalence.
A conservative estimate from the Bureau of Labor Statistics household-based survey of “alternative work arrangements” suggests that gig workers “in non-standard categories” account for about 10% of employment. Alternatively, other researchers estimate the prevalence as three times as common, or 32.5%, using a Federal Reserve survey that broadly defines gig work to include any work that is temporary and variable in nature as either a primary or secondary source of earnings. And when freelancing platform Upworks and consulting firm McKinsey & Co. use a broader concept of “independent work,” they report rates as high as 36% of employed respondents.
No consensus definition or measurement approach has emerged, despite many attempts, including a 2020 panel report by the National Academies of Sciences, Engineering, and Medicine. Various estimates do suggest several common themes, however: Gig work is sizable, present in both traditional and digital workplaces, and draws upon workers across the age, education, demographic and skill spectrum.
Why it Matters
As the above indicates, gig workers can range from high-paid professionals working on a project-to-project basis to low-wage workers whose earnings are highly variable, who work in nonprofessional or semiprofessional occupations and who accept – by choice or necessity – volatile hours and a short-term time commitment from the organization paying for that work.
Regardless of their professional status, many workers operating in gig arrangements are classified as independent contractors rather than employees. As independent contractors, workers lose rights to a minimum wage, overtime and a safe and healthy work environment as well as protections against discrimination and harassment. Independent contractors also lose access to unemployment insurance, workers’ compensation and paid sick leave now required in many states.
Federal and state laws differ in the factors they draw on to make that call. A key concept underlying that determination is how “economically dependent” the worker is on the employer or contracting party. Greater economic independence – for example, the ability to determine price of service, how and where tasks are done and opportunities for expanding or contracting that work based on the individual’s own skills, abilities and enterprise – suggest a role as an independent contractor.
In contrast, if the hiring party basically calls the shots – for example, controlling what the individual does, how they do their work and when they do it, what they are permitted to do and not do, and what performance is deemed acceptable – this suggests employee status. That’s because workplace laws are generally geared toward employees and seek to protect workers who have unequal bargaining leverage in the labor market, a concept based on long-standing Supreme Court precedent.
Making Work More Precarious
Over the past few decades, a growing number of low-wage workers find themselves in gig work situations – everything from platform drivers and delivery personnel to construction laborers, distribution workers, short-haul truck drivers and home health aides. Taken together, the grouping could easily exceed 20 million workers.
Many companies have incentives to classify these workers as independent contractors in order to reduce costs and risks, not because of a truly transformed nature of work where those so classified are real entrepreneurs or self-standing businesses.
Since gig work tends to be volatile and contingent, losing employment protections amplifies the precariousness of work. A business using misclassified workers can gain cost advantages over competitors who treat their workers as employees as required by the law. This competitive dynamic can spread misclassification to new companies, industries and occupations – a problem we addressed directly, for example, in construction cases when I led the Wage and Hour Division and more recently in several health care cases.
The future of work is not governed by immutable technological forces but involves volitional private and public choices. Navigating to that future requires weighing the benefits gig work can provide some workers with greater economic independence against the continuing need to protect and bestow rights for the many workers who will continue to play on a very uneven playing field in the labor market.
For Now, Innovation and Entrepreneurship Still Hold a High Place in the USA
Commentators worry that the United States might lose its dominance in innovation to Asian countries like China and Singapore. Many policymakers are intimidated by the R&D budgets of Asian countries and by their superior performance on international academic assessments. However, these concerns are misguided because the United States still dominates innovation.
The United States ranks second on the Global Innovation Index and scores the highest in the world on fifteen of eighty-one innovation indicators. The US innovation ecosystem continues to lead in the commercialization of research, and its universities are on the cutting edge of academic research. Other countries are expanding research budgets, but the United States’ genius is its ability to commercialize relevant innovations.
Innovations are only useful when they disrupt industries by transforming society and altering consumer preferences. Because innovations respond to market changes, anything can become an innovation, and the process is highly spontaneous. Unfortunately, too many countries are laboring under the assumption that government plans inevitably lead to innovation. Finding the next game changer is tremendously difficult due to the dynamism of consumer preferences.
US entrepreneurs appreciate that innovation is a freewheeling process rather than an object of grand design. That is why Silicon Valley, with its reverence for risk and failure, has been known for innovation. In her 2014 book, The Upside of Down: Why Failing Well is the Key to Success, Megan McArdle argues that the United States’ tolerance toward failure is a crucial pillar of prosperity because it promotes self-actualization, risk, and the continuous quest for innovation.
The United States’ rivals have eloquent five-year plans and extravagant budgets, but US innovation is undergirded by private institutions with a strong appetite for risk and iconoclastic thinking. Private venture-capital associations and research institutions searching for future pioneers are the primary players in US innovation. Government innovation plans are inherently conservative because they hinge on the success of targeted industries.
But, in the private sector, entrepreneurs are deliberately scouting for disruptors to undercut traditional industries by launching breakthrough products. The conformity of government bureaucracies is an enemy of the unorthodox thinking that spurs innovation. China is known for having a competent and meritocratic civil service, yet scholars contend that it lacks an innovative environment.
A key problem is that China focuses on competing with western rivals instead of developing new industries; innovation is perceived as a competition between China and its rivals rather than an activity pursued for its own sake. Consequently, US companies remain market leaders and are more adept at converting market information into innovative products than their Chinese counterparts. Unlike China, US entrepreneurship is not a function of geopolitics.
Meanwhile, some commentators suggest that the US education system is better at deploying talent due to its encouragement of unorthodox thinking. In contrast, Singapore and China have been criticized for emphasizing rote learning at the expense of critical thinking. For example, Singapore’s public sector is a model of excellence; however, despite government support, Singapore is yet to become an innovation hotbed.
Bryan Cheung, in an assessment of industrial policy in Singapore, comments on the failure of Singapore to translate research into innovation: “Even though Singapore ranks highly on global innovation indices, closer scrutiny reveals that it scores poorly on the sub-component of innovation efficiency.” A recent edition of the Global Innovation Index, using a global comparison, declared that “Singapore produces less innovation outputs relative to its level of innovation investments.”
Cheung explains that Singapore is heavily reliant on foreign talent to boost innovation: “Even the six ‘unicorns’ that Singapore has produced (Grab, SEA, Trax, Lazada, Patsnap, Razer) were all founded or co-founded by foreign entrepreneurs. In the Start-Up Genome (2021), Singapore also performed relatively poorly in ‘quality and access’ to tech talent, research impact of publications, and local market reach, which is unsurprising since innovation activity is concentrated in foreign hands.”
Asian countries are growing more competitive, but it will take decades before they develop the United States’ appetite for risk, market-driven innovations, and the uncanny ability to monetize anything. The United States’ spectacular economic performance and business acumen are based on its unique culture. Those who bet against the United States by downplaying its culture are bound to lose. The United States’ rivals are still catching up.
About the Author
Lipton Matthews is a researcher, business analyst, and contributor to Merion West, The Federalist, American Thinker, Intellectual Takeout, mises.org, and Imaginative Conservative. Visit his YouTube channel, here. He may be contacted at lo_matthews@yahoo.com or on Twitter (@matthewslipton)
Could There be an Impact on Robinhood Shareholders with the SBF Share Seizure
Creditors and customers of FTX may be able to reclaim some assets that were wiped out as the feds have been seizing the 7.50% stake in Robinhood (HOOD) stock held by Sam Bankman-Fried (SBF). SBF faces charges of fraud and a myriad of financial crimes after the collapse of FTX in November. The impact of the collapse is having an effect on other areas of finance, including assets that had been controlled by SBF. The Robinhood shares are valued near $450 million, and while this may bring some hope or relief to those that will receive a distribution, there is a risk to HOOD investors.
Background
The FTX bankruptcy has left a line of claimants to recapture what they can from the cryptocurrency giant. Bankruptcies are seldom easy; those that could involve layers of fraud become tied up in even larger disputes and legal battles. For example, the large Robinhood holding is tied up in a dispute between FTX and bankrupt crypto lender BlockFi. The company alleges that SBF put up the shares as collateral for a loan to Alameda Research, a company he also owned.
The HOOD stake was purchased in 2022 through a holding company SBF controlled, Robinhood of course is the innovative broker specializing in self-directed individual investors. Through the DOJ, authorities are going after the shares of HOOD and accounts that are held at the bank Silvergate Capital (SI) which is a banker for the crypto industry.
Separately, court filings on January 4th brought awareness to a NY federal judge ordered last month requiring the seizure of some $93 million that an FTX arm held in accounts at Silvergate. As it relates to this seizure. The Justice Department says it believes the assets seized are not the property of the bankruptcy estate, while a lawyer for FTX maintains that the seizures were from accounts not directly controlled by the company. They were ordered in connection with the criminal case involving SBF.
FTX investors’ asset claims in the exchange, which was once valued at $32 billion, come after creditors and other rightful claimants.
How This Could Impact Robinhood Shareholders
Asset seizures and later distribution to those hurt by fraud involve liquidation of the assets seized. In the case of stocks, they will be sold and turned into cash. Imagine a sudden effort to sell 7.50% of any company. That is a large percentage to move. The stake, worth between $400 and $500 million, may serve as a dark cloud depressing share prices and slowing any planned growth of the company. It may eventually culminate in liquidation at a pace not conducive to retaining a level stock price.
One Should Never feel Forced to Trade or Get Involved Because They are Bored
Most start off a New Year with great intentions. These often include saving money, starting a family, or finding a better job. A co-worker of mine is intent on skydiving before year-end – whatever. To each their own. For many involved in the markets, 2023 has become the year they want to further improve their trading. This usually begins with stepping back, reminding themselves of trading basics, then not falling into old habits weeks later. Another step is developing new understanding and new companies. It also includes not trading with the need to make back last year’s losses in a hurry.
There is one trading basic that is often ignored because it feels like it conflicts with other goals. But it doesn’t. It is knowing when being uninvolved is the best decision. Doing nothing without feeling you may be missing something takes practice for most. It may take more practice for those that have experienced the thrill of a mostly green trading account.
Trade No Stock Before its Time
Over the holidays, family members would ask, “should I buy Tesla?” or “should I be buying Apple down here?” My mom would instead ask, something that in my mind is a similar question. She’d ask, “when are you going to get married?” These are all similar because Tesla and Apple, when considering the whole universe of stocks, are probably not the best fit for the accounts of these people. Similarly, in the absence of finding a good personal fit, unless someone is holding a gun to one’s head, I believe in waiting for circumstances with a high probability of a positive outcome. Don’t get involved because you’re bored, or because you think you have to is the message.
If your win rate is over 50%, you’re doing better than average, this is as true in trading as it is in relationships. If you force either, your success rate goes down, and you’ve wasted time, money, and invited frustration. Yet so many investor/traders willy-nilly jump into something because they are bored, feel they are missing out, or are told it is what they are supposed to be doing.
Forcing trades, no matter how tempting it may be, how bored you are, or how much FOMO you’re experiencing, has a lower chance of being successful than if you wait for your perfect setup. Sitting on your hands so you can’t press the “Buy” button is preferable to being in the situation of trying to unwind a trade you spent too little time waiting to come to you. Good opportunity doesn’t always arrive on schedule, but if you have capital tied up in a mistake, you may not be able to jump at a real match for your portfolio later on.
Trading is Not Glamorous
The definition of booyah is “expressing triumphant exuberance.” If you yearn to say “booyah” or do any other kind of touchdown dance, you may find you will pull the sell trigger too early. A main key to trading is knowing what you want, then patience. Patience is one of the most important skills you can have as a trader. You need to have the control and the discipline to wait for a quality setup according to your individual strategy. It may take a while, but confidence the trades will come helps. Develop a trading strategy so you know the guidelines you will adhere to; abandoning that strategy just to be involved, over time, will cause you to be worse off.
Consistently successful traders will tell you that one of the most important things to remember with trading is that you should never let your emotions control your actions. If you can’t think rationally if you aren’t planning your trade and trading your plan, sit on your hands until you can. Really, defund your account, find another way to get your thrills. Because if you force a trade and it works out anyway, you have reinforced a bad habit. Many trading accounts of good people got fried in 2022 because they did the wrong thing in 2021, but in 2021 they were bailed out by the markets. Doing the wrong thing and succeeding is costly because you tend to repeat it.
A hail Mary pass sometimes meets the desired goal in a football game, swinging for a home run in baseball and connecting certainly can lead to exuberance and even a winning game. But most often, these are low-probability irrational plays if you actually want to win. Increase your time on base, work on your short plays, study your opponent, or whatever other kind of reference helps convey this thinking. Because saying “I do” to a stock without successful due diligence is like asking to eventually lose. If you just want excitement, then maybe you could consider skydiving.
Final Thoughts
We’re all always learning. Channelchek is a good way to discover less explored companies and to either learn or be reminded of things that may enhance your positive outcomes. Sign up now, there’s no paywall, just good info not found on more mainstream investment sites. Go here.
Image: Michael Burry on the Set of “The Big Short” (Twitter, @michaeljburry)
Washington’s Economic Playbook According to Michael Burry
One benefit to Elon Musk purchasing Twitter and ridding the platform of many of the auto posts on well-followed accounts is that the well-followed Michael Burry is no longer deleting his tweets the same day as posted. Burry, who began the new year tweeting with a very clear economic roadmap, said less than a month ago that he trusts Elon. As far as the hedge fund manager’s 2023 economic roadmap, his expectations show that he is critical of all those in Washington that have a hand on the economic steering wheel and continue to resist oversteering.
Source: Twitter (@michaeljburry)
While it can be frustrating for someone like Burry or any investor to forecast missteps by those that most impact the economy, especially if the official entities continue to repeat their behaviors, there is some consolation in the idea that patient investors can use these repeated actions to enhance their account’s performance.
Burry’s New Year’s Message
In 50 words, Dr. Burry, the investor made famous by Christian Bale’s portrayal of him in the 2015 movie The Big Short, said that he expects that inflation for this part of the interest rate, or market cycle, has already passed its high. In fact, he expects that it will be unmistakable, as the year progresses, that the US has fallen into a recession. A recession that can’t be denied or redefined because it will be that deep.
With this economic weakness, the hedge fund manager expects that we will not only see lower CPI readings but by the second half of this year, inflation may even turn negative – deflationary readings.
Burry then goes on to say that this will cause stimulus from both the fed and fiscal policy. This stimulus will be overdone if keeping inflation at bay is the goal. He expects we will have an inflationary period that may outdo the one we are coming off., Burry tweeted. “Fed will cut and government will stimulate. And we will have another inflation spike.”
Source: Twitter (@michaeljburry)
Take Away
If you ask ten experts what will happen over the next 12 months, you will get ten or more conflicting projections. The Scion Asset Management CIO is often correct on what will eventually occur but just as often as he is right, he is far off on the timing. The scenarios that seem obvious to him have in the past played out a lot slower in the economy and marketplace.
His first tweet in 2023 said that he expects more of the same from the folks in Washington, including the Federal Reserve and the US Treasury. The fed is now pushing hard on the economic brake pedal, which will could cause activity to reach recessionary levels. He expects that this will be followed by a panic move to the gas pedal that will create shortages, increased demand, and consumer price increases.
If he is correct, this means different things to investors with different time horizons. But it appears that Burry expects the tightening cycle to end soon.
The Year 2022 Brought Many Twists and Turns to Share with Readers – the Editor Picks His Favs
All markets are interconnected. In fact, markets are impacted by weather, war, worry, Washington, wages, waste, and that’s just the W’s. So each day, as Channelchek prepares to deliver research, articles, and pertinent video content to subscriber’s inboxes, we plow through a mountain of information and hope to share what is either not being addressed or covered, or present front page news from the point of view of seasoned investors, not rookie news writers.
Below are five articles that were published throughout the year on Channelchek. Although I have favorites not included here, and these are not the most read, I believe the below told a slightly different story than the mainstream narrative. As a content provider to this popular investment research platform, my job is not to call the market, it is to provide thoughts and knowledge to help you make decisions on small and microcap stocks and the overall universe of investment opportunities. Still, the content team is proud when, for example, the entire newswire exploded with the word “pivot” that we then reminded our readers there was nothing indicating a pivot was imminent or even being discussed among FOMC members. As most Channelchek content providers are investors, analysts, and market watchers, we were also proud to serve our readership by being among the first to dig through the $AMC $APE dividend and define the true effects to stakeholders.
I think you’ll find these five articles are still compelling, and if you have not registered for no-cost insights to your inbox each day, here’s your chance to start the New Year from a slightly different investment angle.
“So, ladies and gentlemen, gentlemen and ladies, TODAY WE POUNCE.” This is how the AMC Chairman began his letter to shareholders on August 4. The company announced a unique dividend to be awarded to listed shareholders later in the month. The impact of the dividend is still being felt and discussed among market participants.
In this article explaining the Fed not pivoting but instead doubling down on describing a strong hawkish bias does not necessarily mean bad news for investors in stocks. It’s a follow-up article to Don’t Fear the Rate Hike, which was widely read and shared on social media. There is information in the above Fed pivot article that I am certain will be as pertinent in 2023 as it was in 2022.
#3 What Investors Haven’t Yet Noticed About the Value in Some Biotechs
If you’re shopping for a wallet and one comes complete with $100 worth of cash inside and is priced at $60, would you think there is value to this purchase? A situation similar to this has evolved in many biotech stocks. The article was written in late May, and although it has only played out for a few companies in the sector, conditions still exist for a feeding frenzy in biotech stocks. Information within the article could also apply to other sectors that have lost popularity post Covid19.
The only real contact hedge fund manager Michael Burry has with the outside world is Twitter posts (which, since Musk’s arrival, Burry now promises not to delete), his quarterly SEC filing of holdings, and every four or five years he will allow an interview with Bloomberg via Bloomberg Msg. Investment content providers are all over every tweet and quick to tell the world what it means. There are even YouTube channels that exist only to guess at what Burry’s portfolio at Scion may hold and what Burry (maybe) thinks. They do this because many readers swarm to learn more about what he is preparing for.
Some of the most widely read and long-lived content on Channelchek are articles about this guru. Still we promise to only present his tweets, filings, and thoughts when the information seems useful.
Written in late April, this article hit a need that stayed important to readers throughout 2022. While the exact numbers are no longer current, the knowledge of how one market impacts another is always worth tucking away in the back of your brain so that, as an investor or trader, you can be early on building a position rather than later when the trade may have already hit the news and lost the bulk of its move. While there are always moving pieces, especially when it comes to currency strength, this article, most often discovered through Google searches, is super short but contains useful information.
Happy New Year
Thank you for letting us be a part of 2022. In the coming year, we have plans to continue everything we are now doing and add on some features that we believe will provide users with relevant information not found in too many other places.
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I don’t think I’m a very good businessman. I act too much with the heart. – Pelé
If you treat the holdings in your trading account with any attachment, your ability to sell at the right time will be hindered, and your profit potential will suffer. Ideally, an active trading account accumulates when the selling volume reaches a peak, prices are cheap, and lightens up when prices are sufficiently above the purchase price. Or when there appears to be better used for the account’s capital — including moving to cash equivalents.
The Pelé quote above reminds me of many active traders; they enjoy the rush of playing and know they can only claim a victory when on the field and in play. These traders often stay on the field too long and accumulate losing positions. The markets are not a game where the odds of winning or losing are equal on any given day. Trading the markets is better thought of as a business that, at times should increase inventory and at times scale down.
Think of Your Trading Account as a Business
I struggled this week as I had two positions in the red that, for tax reasons, I should let go of to offset gains and the taxes that go along with those gains. These positions are not acting poorly, but they are negative, and they both are taking longer than I had hoped to pay off. Each easily allows me to immediately purchase a similar position without upsetting the IRS. But I have hesitated to sell all week.
If trading is a business, one does what is believed to net the most profit – always. I’m usually pretty good at this, but these two small positions would represent my first losses of the year in my trading account (hurray for me). I was fortunate enough to spot the market’s relentless one-direction trend in 2022, this allowed me to ride the downward waves. The trend seems to be continuing, so exiting these two holdings and getting back into something with similar attributes makes solid business management sense. But it isn’t that easy, I’m a competitive person. The “sportsman” side of me did not want to take any losses after dozens of wins. Today, the last day of the year, I woke and told myself the intelligent thing is doing what should net more money – not what will net bragging rights over win percentage.
There are many other reasons people don’t sell when the probabilities indicate they should. One is not pre-determining if the trade is behaving as expected; another is falling in love with a stock and not wanting to part with it. Another is knowing you were once up and not wanting to permanently lock in something that is now red. Another may be “addiction to the game,” this burns money; a good trader should be comfortable sitting with a large cash position for weeks or months if that is what makes the most business sense.
All of these feelings that impact behavior are part of being human. There are plenty of other outlets to act on feelings outside of the markets, but investing requires you to act as though you are running a business. Don’t fall in love with your positions, and if they aren’t treating you well, get rid of them.
Image Credit: Mike W. (Flickr)
Car Lot Owner Mentality
This may not work for everyone, but I think of my trading account (not retirement savings) as a used car lot. I am the manager and every one of the cars represents something I want to sell. If you look at your account in this way, stocks are just inventory. If times are good and prices are rising on my inventory, I want to slow down the pace of my selling. When times ahead look as though people may not want the kind of inventory on my lot, I can’t sell fast enough, even if at a loss. The cash then raised serves as dry powder that stands ready to be invested in cars/inventory/stocks believed to be more in demand. Inventory that will provide more of a profit.
By thinking of my account as a car lot, I avoid 95% of the mental, “acting with the heart” trading missteps that I see others get trapped by. I still have a 5% problem that includes wanting a perfect score.
Investors buying and selling on an exchange have a huge advantage over managers of a car lot. For most exchange traded securities, finding someone to close out your position with does not require someone walking in off the street that just happens to want what is on your lot. Investors of securities have sell buttons that alert the investment community that you are unloading. Even thinly traded securities will have someone take the other side of the trade at the right price. There are no other businesses in the world where unwanted inventory is this easy to unload. Traders are like car lot owners with this unique advantage.
Don’t Coddle the HODL Model
While buy and hold may be a good long-term portfolio strategy for retirement money or other long-term assets, holding without reason other than the investment community encourages you to “HODL” forever and not to throw in the towel can get you in trouble. The HODL community encourages investors of certain assets to Hold On for Dear Life; this isn’t trading; it’s a recipe for an ulcer.
When does it make sense to close out a position? In general, there are some marketplace related reasons to unwind a position. These are reasons that are related to the company, changes in the markets, or better opportunity elsewhere. Or non-market-related outside reasons. Perhaps one wishes to use some of the profit to put in a pool, or they wish to stem possible losses while waiting for better clarity. Outsiders encouraging an entire community to hold a position to help push up its price only works until greed kicks in and those sworn to HODL realize the stock is up for unnatural reasons and they should be among the first out.
Kneejerk market reactions to news or events can cause a wave of selling or buying that then settles down and reverses somewhat. This may provide an opportunity to unwind positions into the feeding frenzy and re-enter it when the market settles in at a more level-headed price.
Broaden Investment Base
If you are a used car lot owner during a recession, you may opt to only half-fill your lot and make sure the cars in inventory are affordable to the community you serve. If the economy fires up and money is then widely available, you may want to maximize your inventory and make sure they are cars that will net the most profit. It is important to know a lot about different classes of cars. This is how you run that business, minivans and crossovers some years, even if you like British sports cars.
For trading, after the pandemic plunge in early 2020, the markets had solid trends. First up with many sectors outpacing the others. Then it trended down, with many sectors outpacing the others. Understanding the sectors and companies within the sectors allows better decisions. If you have spent all your time wondering whether you should get into Apple or Tesla at the exclusion of others, while oil companies or utilities were what had a clear trend, or in Nasdaq 100 stocks because the media always talks about them, when small-caps were making their move, you may wish to broaden your focus.
Take-Away
Internal trouble exiting positions impacts more self-directed investors than will ever admit to it on social media (or actual in-the-flesh interaction). If thought of as inventory and a tool for maximizing return, the trouble is put in a place most can handle, as a “business owner,” you are buying what you feel you can sell. That is the only reason to buy. If you don’t know if you can sell it higher tomorrow, but there is something that you believe you can, then perhaps it is time to evaluate dumping, even at a loss, to pick up something else.
Cash can often be that something else. Earning 4% annually on a short t-bill isn’t sexy, but having that liquid holding when opportunity presents itself, allows you to pounce. There is nothing worse than seeing something very clearly as a winning trade and not having the capital to load up on it.
Inflation, Unemployment, the Housing Crisis, and a Possible Recession: Two Economists Forecast What’s Ahead in 2023
With the current U.S. inflation rate at 7.1%, interest rates rising and housing costs up, many Americans are wondering if a recession is looming.
Two economists discussed that and more in a recent wide-ranging and exclusive interview for The Conversation. Brian Blank is a finance professor at Mississippi State University who specializes in the study of corporations and how they respond to economic downturns. Rodney Ramcharan is an economist at the University of Southern California who previously held posts with the Federal Reserve and the International Monetary Fund.
Both were interviewed by Bryan Keogh, deputy managing editor and senior editor of economy and business for The Conversation.
Are we headed for a recession in 2023?
Brian Blank: The consensus view among most forecasters is that there is a recession coming at some point, maybe in the middle of next year. I’m a little bit more optimistic than that consensus.
People have been calling for a recession for months now, and this seems to be the most anticipated recession on record. I think that it could still be a ways off. Consumer balance sheets are still relatively strong, stronger than we’ve seen them for most periods.
I think that the labor market is going to remain hotter than people have expected. Right now, over the last eight months, the labor market has added more jobs than anticipated, which is one of the strongest streaks on record. And I think that until consumer balance sheets weaken considerably, we can expect consumer spending, which is the largest part of the economy, to continue to grow quickly.
[But this] doesn’t mean that a recession is not coming. There’s always a recession somewhere down the road.
Rodney Ramcharan: Indeed, yes, there’s a likelihood that the economy is going to contract in the next nine months. The president of the New York Fed expects the unemployment rate to go up from 3.5% currently to somewhere between 4% to 5% in the next year. And I think that will be consistent with a recession.
In terms of how much worse it can be beyond that, it’s going to depend on a number of things. It could depend on whether the Fed is going to accept a higher inflation rate over the medium term or whether it’s really committed to getting the inflation rate down to the 2% rate. So I think that’s the trade-off.
Will unemployment go up?
Blank: [Unemployment] hasn’t risen much, and maybe it’ll pick up to somewhere close to 4%. Many are expecting something like four and a half percent. And I think that’s certainly possible. And I think that we can see small upticks in the coming months.
But I don’t think it’s going to rise as quickly as some people are expecting, in part because what we’ve seen so far is a lack of labor force participation. Until more people enter the labor market, I think there are going to be plenty of jobs to go around.
What is your outlook on interest rates?
Ramcharan: As people find it more and more difficult to find jobs, or to get jobs as they begin to lose jobs, I think that’s going to dampen spending. And we’re seeing that now as the cost of borrowing has gone up sharply, and the Fed is expecting that.
The expectation is the federal funds rate will go up to 5% by next year. If you tack on another couple of points, because of the risk involved, then the cost to borrow to buy a home could potentially get up to 8% for some people. And that could be very expensive.
And the flip side of this for businesses is there’s potentially going to be a slowdown in cash flow. If consumers are not spending, then the revenues that businesses depend on to make investments might not be there.
The additional piece in this puzzle is what the banks will then do. I think banks are going to begin to curtail the extension of credit. So not only will interest rates go up for the typical consumer and the typical business, it’s also likely that they are more likely to experience denial of credit, and so that should together begin to slow spending quite a bit.
After massive increases in housing prices, what caused them to suddenly drop?
Ramcharan: As the Fed lowered interest rates, there was a massive shift among the population for various reasons. They decided that housing was the right investment or the right thing. And so when 50 million people all collectively decide to buy homes, the supply of homes is reasonably constrained in the short run. And so that led to this massive increase in house prices and in rents.
In the last three months, the housing market has cooled sharply. We’re now seeing house prices beginning to fall. I would imagine, going forward, the housing market cooling is going to be a major driver behind the slowdown in the inflation rate and in real estate investment trusts. So that’s positive.
Our recent election just changed the composition of Congress. How will that affect the economy?
Blank: Certainly, when we have a divided Congress, we’re less likely to see decisions made that involve passing legislation that might support the economy. And I think it’s likely the Republican House is going to become a little bit more conservative with spending.
And so if we do start to see a downturn, I think you’re less likely to see legislation that might help support an economy that could be in need of it. That is going to make the job of the Federal Reserve more important.
How certain are these predictions?
Ramcharan: I just want to be careful here and let your viewers know that we’re making these statements based on theory, because the inflation that we’re experiencing now comes about from a pandemic, and there really is no evidence, there’s no data available, that people can look to to say, “What happens to an economy after a pandemic?” That data does not exist.
So we’re trying to piece together the data we do have with the theories we do have, but there’s a huge band of uncertainty about what’s going to happen.
As the Bear Market Melts Down, Where Will the Grass Be Greenest?
Bear Markets and snowmen have one thing in common; they don’t last forever.
The entry point into an investment can have a huge impact on performance. Exits tend to be more critical when the stock has shown that it is not performing as planned. While this kind of exit may result in a loss, it allows the investor to preserve capital, liquid assets they can deploy if another good entry presents itself. The major stock market indices for 2022 are down 20% and more. Has this sell-off provided for performance-producing entry points in some stocks? Let’s look where we are as the countdown to 2023 has already begun.
About this Bear Market
Bear markets end – they always have. Pinpointing an exact bottom is not possible, so trying to be the first in for that great entry point may include a few false starts and some unhoped-for exits. The current slide in the stock market started around January 1, 2022. This was because some doubted whether inflation was transient at the time; by March, most understood the Fed was concerned that price increases were pervasive.
Fed Chair Powell, along with many Fed Presidents, began speaking hawkishly to not unduly surprise and unsettle markets as the central bank unwound the liquidity used in response to the novel coronavirus. What followed was unprecedented. Overnight lending rates went from an effective 0.08% to an effective 4.33% during the course of the year. This is more than 52 times the base lending rate at the start of the year. With these increases, no wonder the bear market continued.
Where Are We Now?
Expectations of overnight rate hikes in 2023 are for another 0.50%-0.75% increase leaving the target at, or just north of, 5%. This increase in the cost of money is small (.17 times) compared to the massive (52 times) rocking the markets in 2022.
So rate hikes are expected to be much lower as a percentage of current rates next year. And after the last FOMC meeting, markets have seemingly repriced lower with this expectation. If all goes as it is thought it will, the market is already priced for the worst. This is a bullish sign.
Put another way; most believe that with Fed funds beginning 2022 around zero, we’re likely much closer to the end of the Fed Funds tightening than to the beginning.
Inflation (CPI) for December won’t be reported until January 12, 2023. The latest CPI numbers show YoY up 7.1% in November, a slowing from 7.7% in October, which tapered from 8.2% the month before. The November reading of 7.1% taken by itself is a long way away from the Fed’s 2% target. But the trend in the CPI and PCE deflator also suggest the Fed is likely to monitor previous hikes to see if they will have the desired impact.
The Fed Has Been Transparent
The Fed lowered rates in line with what they promised during the pandemic. Then after some transient talk, they raised rates as they expressed they would in 2022. Following the December FOMC meeting, they suggested they were not at the end, but the voting members’ expectations for where they will settle is an average of 5.40%. The forward-looking stock market, if they believe the Fed will again do as promised, should recognize this is a much lower increase. It is perhaps near the time to begin to build on positions. This could be the entry point many investors have been waiting for.
Small Cap Phenomenon
The chart below shows how much small cap stocks outperformed during the 12- months following the pandemic plunge. While small cap outperformance has been experienced during the past century of stocks’ post-sell-off periods, one only has to look back to the pandemic plunge to remember that it was small-caps (depicted below as IWM) that had been beaten down the most and by far outran the other major indices for the next year from the low of 2021.
Could this small cap phenomenon occur again after markets reach the bottom? Data demonstrates that small cap stocks tend to lead following a period of economic dislocation. One reason is US small caps have more of their business within the states and as a bonus, do well with a rising dollar. Current conditions suggest exploring smaller stocks. They have outperformed large caps following nearly every bear market of the last century. And today, the dollar has risen above its six-month high and is trending higher. While past movement comparisons don’t always include all the crosscurrents of the future, a strong argument could be made that a turnaround is near and small caps may again be the leaders by a wide margin.
Some Disclosure
Channelchek, the investment information platform you’re now reding has small cap stocks as its primary focus. The deep platform provides data on over 6000 stocks, with quality research updated regularly on many of them. Channelchek also provides videos and articles that may inspire informed stock selection. Stock selection, rather than just plowing investment dollars into an indexed ETF, may be preferable as indexed ETFs include sectors and stocks that may not be worthy of your portfolio.
Diversification across asset classes, sectors, and market capitalizations is considered prudent for long-term portfolios; individual allocations can be built on depending on where we are in the business and interest rate cycle. This includes an allocation to small cap equities, which perhaps should be expanded if the Fed is near the end of its tightening cycle. It could always be reduced later if the economy is deep into a growth cycle.
Take Away
Although we do not have a crystal ball to know exactly when the best entry point in any company stock is, if a century’s worth of data is any guide, the period following the end of a market downturn has been a good time to increase exposure to the small cap sector.
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The Difficult Reality of Rising Core and Super-Core Inflation
While many market participants are concerned about rate increases, they appear to be ignoring the largest risk: the potential for a massive liquidity drain in 2023.
Even though December is here, central banks’ balance sheets have hardly, if at all, decreased. Rather than real sales, a weaker currency and the price of the accumulated bonds account for the majority of the fall in the balance sheets of the major central banks.
In the context of governments deficits that are hardly declining and, in some cases, increasing, investors must take into account the danger of a significant reduction in the balance sheets of central banks. Both the quantitative tightening of central banks and the refinancing of government deficits, albeit at higher costs, will drain liquidity from the markets. This inevitably causes the global liquidity spectrum to contract far more than the headline amount.
Liquidity drains have a dividing effect in the same way that liquidity injections have an obvious multiplier effect in the transmission mechanism of monetary policy. A central bank’s balance sheet increased by one unit of currency in assets multiplies at least five times in the transmission mechanism. Do the calculations now on the way out, but keep in mind that government expenditure will be financed.
Our tendency is to take liquidity for granted. Due to the FOMO (fear of missing out) mentality, investors have increased their risk and added illiquid assets over the years of monetary expansion. In periods of monetary excess, multiple expansion and rising valuations are the norm.
Since we could always count on rising liquidity, when asset prices corrected over the past two decades, the best course of action was to “buy the dip” and double down. This was because central banks would keep growing their balance sheets and adding liquidity, saving us from almost any bad investment decision, and inflation would stay low.
Twenty years of a dangerous bet: monetary expansion without inflation. How do we handle a situation where central banks must cut at least $5 trillion off their balance sheets? Do not believe I am exaggerating; the $20 trillion bubble generated since 2008 cannot be solved with $5 trillion. A tightening of $5 trillion in US dollars is mild, even dovish. To return to pre-2020 levels, the Fed would need to decrease its balance sheet by that much on its own.
Keep in mind that the central banks of developed economies need to tighten monetary policy by $5 trillion, which is added to over $2.50 trillion in public deficit financing in the same countries.
The effects of contraction are difficult to forecast because traders for at least two generations have only experienced expansionary policies, but they are undoubtedly unpleasant. Liquidity is already dwindling in the riskiest sectors of the economy, from high yield to crypto assets. By 2023, when the tightening truly begins, it will probably have reached the supposedly safer assets.
In a recent interview, Bundesbank President Joachim Nagel said that the ECB will begin to reduce its balance sheet in 2023 and added that “a recession may be insufficient to get inflation back on target.” This suggests that the “anti-fragmentation tool” currently in use to mask risk in periphery bonds may begin to lose its placebo impact on sovereign assets. Additionally, the cost of equity and weighted average cost of capital increases as soon as sovereign bond spreads begin to rise.
Capital can only be made or destroyed; it never remains constant. And if central banks are to effectively fight inflation, capital destruction is unavoidable.
The prevalent bullish claim is that because central banks have learned from 2008, they will not dare to allow the market to crash. Although a correct analysis, it is not enough to justify market multiples. The fact that governments continue to finance themselves, which they will, is ultimately what counts to central banks. The crowding out effect of government spending over private sector credit access has never been a major concern for a central bank. Keep in mind that I am only estimating a $5 trillion unwind, which is quite generous given the excess produced between 2008 and 2021 and the magnitude of the balance sheet increase in 2020–21.
Central banks are also aware of the worst-case scenario, which is elevated inflation and a recession that could have a prolonged impact on citizens, with rising discontent and generalized impoverishment. They know they cannot keep inflation high just to satisfy market expectations of rising valuations. The same central banks that assert that the wealth effect multiplies positively are aware of the disastrous consequences of ignoring inflation. Back to the 1970s.
The “energy excuse” in inflation estimates will likely evaporate, and that will be the key test for central banks. The “supply chain excuse” has disappeared, the “temporary excuse” has gotten stale, and the “energy excuse” has lost some of its credibility since June. The unattractive reality of rising core and super-core inflation has been exposed by the recent commodity slump.
Central banks cannot accept sustained inflation because it means they would have failed in their mandate. Few can accurately foresee how quantitative tightening will affect asset prices and credit availability, even though it is necessary. What we know is that quantitative tightening, with a minimal decrease in central bank balance sheets, is expected to compress multiples and valuations of risky assets more than it has thus far. Given that capital destruction appears to be only getting started, the dividing effect is probably more than anticipated. And the real economy is always impacted by capital destruction
Fed Chairman Powell is Being Ignored by the Markets – What Next?
Is Fed Chairman Powell getting the George Costanza treatment from the bond market? I asked myself this as I listened to the Chair double down on his hawkishness yesterday while at the same time watching the bond market yawn. Rates were effectively unchanged out in the periods. It reminded me of the Seinfeld episode where George tells his girlfriend, point blank, I’m breaking up with you.” She simply replies, “No.” Similar to George, Powell’s wishes are not being recognized by the market which would be hurt by them. Today mortgage rates dropped along with treasury yields, this all makes Powell’s job tricky.
The FOMCs final episode of the 2022 season ended as expected with a 50 bp increase, and the Fed Chairman addressing reporters and trying to be taken seriously by the markets. Afterall, he can say he’s raising rates all he wants to slow growth, if lending rates don’t rise, the Fed doesn’t achieve its goal. Since October 24, the Fed has raised overnight rates 1.25%. As seen below in the chart, despite the increase from a 3% target to a 4.25% target (which is a 42% increase in bank lending rates), the ten year which is a benchmark for consumer lending rates, declined by 0.75% (which is an 18% decline).
Markets are forward looking. Currently they seem to be, more farsighted than usual. As Chairman Powell repeats after each increase that officials anticipate that “ongoing increases” in the Fed Funds rate will be “appropriate,” this would be expected by someone of Powell’s experience to cause the market to look toward rate increases and shift the yield curve higher. The Fed has done more than this. The official one-year-out Fed forecast is for the Fed funds rate to end 2023 at 5.1% and 4.1% for 2024. These were 4.6% and 3.9% previously. Mortgage rates today hit recent lows.
Meanwhile overnight interest rates this year have increased by 50 times from where they started (.08% to 4.00%). By comparison the benchmark Treasury was trading at 1.73% at the start of the year, so its level has gone up by two times.
But the current market has been so forward-looking in 2022, that each time the Fed puts on its hawkish face, the bond markets take it as more assurance that the U.S. will fall into a recession. They trade on the reassurance that the Fed will need to ease, and it effectively eases borrowing rates as benchmark yields decline. The bond and even stock markets expect the tightening to be transitory. They also only half listen to the Fed Chair because they know how wrong he was when he suggested inflation was transitory just one year ago.
CPI is also causing markets to be optimistic. Two consecutive consensus misses of inflation have led the participants to believe we are getting very close to the peak for interest rates, and rate cuts will soon be on the agenda. The Fed has been doing everything it can to change people’s minds.
The Fed’s View
While the market may be saying “no” and not allowing Powell to impose higher rates along the curve, the Fed certainly is going to keep trying. A 2% inflation target with inflation running approximately three times this won’t allow for an easing of policy. Even if overnight Fed Funds are so high that they are near historical norms.
For the Fed to accept what the market is pricing for, it will want to see substantial evidence that inflation is slowing. This will take more than just one or two months, where core inflation has come in less than the market was expecting. It isn’t an exact science to bring down inflation, but mathematically to get inflation to 2% YoY, over time, we need to see month-on-month readings averaging 0.17% MoM. We are not close, considering it is the core PCE deflator that the Fed pays the most attention to. In fact, the Fed just revised its inflation forecast upward because the core PCE deflator is likely to be stickier than core CPI. The revision has its core PCE estimate at 3.5% for the end of 2023 versus 3.1% previously, with 2024 revised up to 2.5% from 2.3%.
Take Away
What happens when monetary policy throws us huge increases in Fed Funds in seven out of its eight meetings, and late in the year, the interest rate markets decides, “No?”
It seems the Fed is working on its ability to jawbone rates higher. We saw this after the FOMC meeting with Powell doubling down on his rhetoric. We can expect more Fed addresses trying to move rates in a way that direct action concerning overnights has failed to accomplish. In the end, it’s the markets that set levels; if the bond market and stock market participants keep taking this hawkish language as recessionary, the hawkish stance could continue to backfire on the Fed.
Comments from Fed Chair Powell emphasized that the FOMC wants financial conditions to “reflect the policy restraint that we’re putting in place”. After all, inflation is indeed still running well above target, the jobs market and wage pressure remain hot, and activity data is pointing to a decent fourth-quarter GDP report after a healthy 2.9% growth rate in the third quarter. Will he succeed? If my memory serves me correctly, in the Seinfeld episode George wound up engaged to the woman he was breaking up with.
