Wednesday, September 14, 2022

Morning Note: Icing on the Cake

So, yesterday delivered the worst day for the S&P 500 since June 2020... That has to be a monster setback, right? 

Well, not to downplay the pain, but that -4.32% move took us merely back to last Tuesday...

Yesterday was all about the August CPI report not cooling nearly at the rate economists, and Wall Street, had anticipated.

It is, nevertheless, ironic that traders pounded stocks to the extent they did... I mean, after all, Fedheads have told us in no uncertain terms that serious tightening was continuing regardless of the latest CPI read... I guess yesterday's action put the icing on that cake, so to speak.

I.e., the Fed's street cred just wasn't there if indeed inflation was set to come off the boil, despite the fact that their 2% target is simply nowhere in near-term reach -- not without a serious recession, that is.

And who can blame traders for doubting Fed resolve? I mean, it's no secret that the "wealth effect" (folks are economically active when they feel wealthy [so maintain policy that keeps asset markets buoyant]) has hugely influenced monetary policy since the days of Alan Greenspan.

But, the thing is, we simply haven't experienced inflation remotely to this degree since the days of Greenspan's immediate predecessor, Paul Volcker. And that, frankly, demands a Volckerian re-think of priorities for today's Federal Reserve.

Problem (big problem!) being, the underlying general setup today isn't remotely what it was when Volcker allegedly, in singlehanded fashion, slayed the 70s inflation dragon. 

You see, back then we had the likes of Ronald Regan and Margaret Thatcher pumping supply side, globally-friendly economic policy into the world... I.e., they unleashed disinflationary forces that combined with Volcker's willingness to attack rising prices in a manner that his predecessors -- who operated within a labor-friendly, protectionist, inflationary regime -- simply couldn't successfully pull off. 

Plus (big plus!), the US was sporting a mere 30% debt to GDP back in those days. I.e., the Fed could hike away without blowing up the credit markets... Today we're facing a debt load to GDP of 123%!! So, no can do on double-digit policy rates.

Legend has it that even Volcker -- himself being prone to recency bias -- was doubtful that his aggressive approach would actually do the trick.

Well, folks, we've come full circle. Globalization has, at least politically-speaking, run its course -- while wealth and income inequality have reached historic proportions. Therefore, the kinds of labor/consumer-friendly, protectionist, inflation-stoking policies that predated Volker, Regan and Thatcher are resoundingly back in vogue.

So what does that (along with historic debt to GDP) mean for present-day monetary policy? Well, it means that getting inflation back to the Fed's 2% target ain't gonna be easy -- not without breaking something in the process. 

We'll see if, as some have suggested, the Fed doesn't actually articulate a goal other than 2% inflation at some point going forward... That's certainly within the realm of possibilities in our view...

Some form of yield curve control (à la the 1940s) -- where the Fed caps longer-term rates while allowing the economy to run somewhat hot -- to over time inflate away that debt to GDP number (i.e., inflate the economy faster than the debt piles up) may ultimately be on the table as well.

As for present-day equities, our base case remains that we're still in the throes of a classic bear market...  I.e., we see a bit more downside (value generation) before this one's all said and done. 

I'll follow up shortly with our mid-week video snapshot...

Asian equities followed US's lead overnight, with all of the 16 markets we track closing lower.

Europe's struggling so far this morning as well, with 14 of the 19 bourses we follow trading down as I type.

US stocks are mixed to start the session: Dow up 20 points (0.06%), SP500 up 0.03%, SP500 Equal Weight down 0.11%, Nasdaq 100 down 0.05%, Nasdaq Comp down 0.14%, Russell 2000 down 0.50%.

The VIX sits at 27.32, up 0.18%.

Oil futures are up 1.67%, gold's up 0.07%, silver's up 1.11%, copper futures are down 0.91% and the ag complex (DBA) is down 0.29%.

The 10-year treasury is down (yield up) and the dollar is down 0.28%

Among our 35 core positions (excluding options hedges, cash and short-term bond ETF), 15 -- led by energy stocks, silver, Asia-Pac stocks, uranium miners and emerging market stocks -- are in the green so far this morning. The losers are being led lower by base metals miners, MP Materials, AMD, Disney and cyber security stocks.

"...the reality of our day-to-day life consists of an endless flow of perceptual interpretations which we, the individuals who share a specific membership, have learned to make in common."

--Castaneda, Carlos. Journey To Ixtlan

Have a great day!

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