Stock market bull comes as optimism returns
Optimism? Oh good? Yes. Widespread media omens still happen just when bad things end. Why? Because the problems and the results are the most obvious. In the stock market, when things are known, they are already taken into account. It is what comes next that is essential. This time, a turnaround is afoot as these negatives carry significant positives. So prepare for optimism.
The three big negative points that are in fact positive points
Three negatives have been the source of widespread omens in the stock markets. The unstable construction of the stock market is a sign that the positive reality is progressing.
- The Federal Reserve is not contraction – it reduces its easy money policies
- Inflation is not uncontrollable and extreme – it is manageable and moderate
- The American economy is not go into recession – positive GDP growth continues
That of the Federal Reserve Talking hard about inflation is louder than its actions. Interest rates, although no longer zero, are still below the rate of inflation – the point at which “tightening” could begin. Until then, the Fed’s easy money machine continues to produce, albeit at a lower rate. Then there are those trillions of dollars that the Federal Reserve “printed” by buying bonds with created demand deposits. The Fed has not yet started to reduce this surplus money supply which is still circulating.
As for inflation, the CPI headline of 9.1% is inaccurate. In my last two articles, “Inflation: scare tactics without understanding” and “Inflation dynamics point to a slowdownI explain how real inflation is much lower. The major concern is the inflation rate of “fiat money”, i.e. the loss of purchasing power caused by excess money. This rate is currently masked by other price increases resulting from abnormal events and actions (Covid 19 impacts, supply shortages and geopolitical disruptions). The rate is probably around 5% – the point above which the “real” (inflation-adjusted) yield on 3-month Treasury bills eventually turns positive again (it’s only 2.4% now ).
This 5% level is also the point at which the Federal Reserve can actually begin to tighten – if he still wants. However, there is a good chance that the abnormal price actions have corrected, leading to a drop in the reported inflation rate. If so, the Federal Reserve can boast success and, more importantly, capital markets will start setting interest rates again without interference from the Fed.
Note: The control of interest rates by the Federal Reserve since 2008 must be considered as an experiment. Not allowing capital markets to do their job of setting prices (interest rates) for more than 13 years means that this US government agency has single-handedly undone the process of allocating capitalism’s key resources.
Now about that recession talk
A major popular concern is that Fed tightening has preceded most recessions (albeit with different time lags). However, as explained above, making money harder is not a crunch. Instead, it is healthy slowing action to temper speculative growth.
“Real” GDP growth was negative in the first quarter and could also be so in the second quarter. The popular view is that double quarter negatives define a recession.
Let’s deal with this popular point of view first. It is incorrect. The NBER (National Bureau of Economic Research) determines if and when a recession occurs after reviewing and evaluating all relevant conditions. Because no two recessions are the same, this assessment necessarily takes time (several months) and is based on both objective and subjective analysis. The delay is why this shortcut, the double drop “rule” was created.
Now for the math problem: overvalued inflation. It is a 3-step process:
- First comes the nominal GDP calculation: 6.0 T$ (a 13% increase compared to the 5.3 T$ of the 1st quarter of 2021, and a decrease of -2.3% compared to the 4th quarter of 2021)
- Next comes seasonal adjustment (SA) to smooth quarterly GDP growth rates which follow a regular seasonal pattern: down in the 1st, significantly up in the 2nd, moderately up in the 3rd and significantly up in the 4th. So Q1 AS was adjusted to $6.1T and Q4 AS was adjusted down to $6.0T. These amounts took quarterly growth from a nominal decline of -2.3% to an increase in SA of 1.6%.
- Third is the inflation adjustment to determine the “real” growth rate. Here is the problem. It was calculated by adjusting the “implicit price deflator” of GDP by 2% (more than 8% at an annualized rate). This caused the seasonally adjusted growth rate to drop from 1.6% to an “actual” (0.4)%. However, this inflation adjustment has abnormal components comparable to the CPI. An accurate inflation rate of 6.6% or less would erase this negative result.
Note: The Federal Reserve’s preferred inflation measure is PCE (Personal Consumption Expenditure) excluding food and energy. For the first quarter of 2022, this rate was 1.27% (5.2% annualized). For comparison, the CPI rate excluding food and energy was 1.58% (6.5% annualized).
The Bottom Line: Optimism Is Coming, So Own Stocks
This slowdown is wiping out the excesses and rising interest rates are reviving moribund engines of growth, the many areas that have been hurt by near-zero interest rates. As interest expense increases, borrowers will become more reasonable. And as interest income rises, the economy will get a big boost from the holders of all those trillions of dollars in short-term assets. In addition, investors will again have options that all produce returns equal to or greater than the inflation rate of “fiat money”.
All of the above means that optimism is around the corner, so now is a great time to hold stocks.