Monthly Outlook: September 2022
The two-month bear market rally came to an end in mid-August. It was nice while it lasted and gave the “buy & hold” crowd some hope. But the Federal Reserve Board (the Fed) poured cold water on the market by clarifying their commitment to fight inflation through tighter monetary policies. We’ll discuss the Fed and their plan later in this Outlook. But first, let’s review the markets. The U.S. stock market is down 16.2%, YTD, and the international stock market is down 19.8%, YTD. Bonds aren’t helping, either, with losses of 10.8%, YTD. Critically, nearly every market is below its 200-day moving average trendline, implying continued downtrends and the need for protection, for now. We’re doing that and our clients’ portfolios are beating the market benchmarks by a solid margin. The irony is that the economy remains strong, even if it is weakening a bit. But that’s the problem. Too much money and confidence, combined with pent-up demand from a pandemic lock-down, has led to spending and inflation. The Fed is determined to fix that, and Wall St. doesn’t like it.
The Fed’s Stimulus Bubble
Nothing excites investors on Wall St. like free money. When the brutal Great Recession hit in 2008, the Fed did its job and provided monetary stimulus to reinvigorate the economy (and markets). The Fed doesn’t technically “print money out of thin air” but it feels that way. Instead, they control the broad money supply through changes to the Fed Funds interest rate, open market operations, and quantitative easing/tightening. There’s no quiz coming here, but the takeaway is that the Fed is very powerful and can manipulate the economy and markets. For that reason, as investors, we should closely follow the Fed.
Before the 2008 recession, the Fed Funds interest rate was 5.25% and the Fed’s balance sheet was only $870 billion. To stimulate the economy, the Fed dropped the Fed Funds rate to 0% and expanded the balance sheet to $4.4 trillion by 2015. That’s an unprecedented amount of monetary stimulus and it created a massive stimulus bubble in asset prices including housing and stocks. The Fed never took its foot off the stimulus pedal for seven years after the 2008 recession, effectively training investors to believe the Fed always has their back (the so-called Fed put). Then the 2020 COVID pandemic hit, and the Fed came to the rescue again. The Fed cut its interest rate to 0% and did another balance sheet expansion to $8.9 trillion! The U.S. has never seen this level of monetary stimulus in 250 years. Now, in 2022, the economy is recovered from COVID, and is awash in money. We have 40-year record-high inflation (around 8%/yr.) and it’s the Fed’s job to fight inflation by tightening monetary policy. But given the Fed’s recent 14-year history of ever-easy money, is it any wonder why Wall St. investors doubt the Fed’s resolve? That changed a little in mid-August.
Jackson Hole Meeting
Every year, top economists and most of the Federal Reserve Board meet in Jackson Hole, WY, to discuss policy and outlook. Often, important speeches are made, and this year was no exception. Although the Fed has repeatedly stated that they’re determined to quell inflation, investors seemed to shrug them off, per the discussion, above. The Fed used the Jackson Hole meeting to make stern and clear pronouncements. They’ve already raised the Fed Funds interest rate from 0% to 2.25%, and they’re almost certainly going to continue until it is 3.75%. Furthermore, they are going to shrink the Fed’s balance sheet at a faster rate, by about $1.1 trillion/year. This got Wall St. investors’ attention and it seems like they finally believe the Fed. The Fed is telling us: The party is over, until inflation is tamed, and that’s going to take longer than investors’ thought (into 2023).
Don’t Fight The Fed, or The Trend
History proves that it’s wise to not fight the Fed and its monetary policy. Nor is it wise to fight price trends. Today, the Fed is tightening, and stock prices are trending lower (below their 200-day moving average). We’ve already taken significant protective measures by selling stocks, putting on hedges, and raising cash. Our core iFolios are moving sideways, as the markets continue to fall. It’s the only prudent way to invest for now. We’ll continue to monitor the Fed and markets and invest for growth when it’s time. The Fed is trying to tell us that could be a while, but we’ll see.