Optimism? For real? Yes. Widespread Media Omen always occur just as the bad things are ending. Why? Because the problems and the results are the most obvious. On the stock exchange, things that are known are already priced in. What matters is what comes next. A turnaround is in the works this time, as these negatives carry important positives. So get ready for optimism.
The three big minuses that are actually positive
Three negative factors were at the root of widespread omens in stock markets. The stock market’s bumpy footing is a sign that positive reality is on the rise.
- The Federal Reserve is Not Put on – It is reducing its easy money policy
- inflation is Not uncontrollable and extreme – it is manageable and moderate
- The US economy is Not entering a recession – Positive GDP growth continues
Those of the Federal Reserve Hard talk about inflation is stronger than his actions. Interest rates, while no longer at zero, are still below the rate of inflation – the point at which a “shortage” could begin. Until then, the Fed’s easy money machine will continue to produce, albeit at a lower rate. Then there are those several trillions of dollars that the Federal Reserve has “printed” by buying bonds with demand deposits created. The Fed has yet to start reducing the excess money that is still in circulation.
Speaking of inflation, the CPI headline is 9.1% inaccurate. In my last two articles “Inflation: Scaremongering without understanding” and “Inflation dynamics point to a slowdown‘ I explain that real inflation is much lower. The real concern is the “fiat money” inflation rate – the loss of purchasing power caused by excess currency. This rate is currently being masked by other rising prices driven by unusual events and actions (impact of Covid 19, supply shortages and geopolitical disruptions). The rate is probably around 5% – the point above which the “real” (inflation-adjusted) yield on the 3-month Treasury bills finally turns positive again (it’s now just 2.4%).
This 5% level is also where the Federal Reserve can actually start tightening – if it still wants. However, there is a chance that the abnormal price movements may have corrected, pushing the reported inflation rate lower. If this is the case, the Federal Reserve will thrive and, more importantly, capital markets will resume setting interest rates without Fed interference.
Note: The Federal Reserve’s rate control since 2008 should be viewed as an experiment. Failing to allow the capital markets to do their job of setting prices (interest rates) for more than 13 years has led this US government agency to single-handedly override capitalism’s most important resource allocation process.
Now for that recession talk
A popular concern is that Fed tightening has preceded most recessions (albeit with varying time lags). However, as explained above, tightening it doesn’t mean making money any less easy. Instead, it’s a healthy deceleration measure to dampen speculative growth.
Evidence that a recession is underway is now being cited that ‘real’ GDP growth was negative in the first quarter and could be negative in the second quarter. The common view is that the double negative quarterly numbers define a recession.
Let’s deal with this popular view first. It is wrong. The NBER (National Bureau of Economic Research) determines if and when a recession will hit after examining and assessing all relevant conditions. Since no two recessions are the same, this assessment necessarily takes time (many months) and uses both objective and subjective analysis. The time lag is why this shortcut, the dual drop “rule”, was created.
Now to the calculation problem: Excessive inflation. This is a 3 step process:
- First comes the nominal calculation of GDP: T$6.0 (a 13% increase from T$5.3 in Q1 2021 and a decrease of -2.3% from Q4 2021)
- Second is seasonal adjustment (SA) to smooth quarterly GDP growth rates that follow a regular, seasonal pattern: down in 1st, significantly up in 2nd, moderately up in 3rd and significantly up in 4th. Q4 adjusted to T$6.1 and SA adjusted to T$6.0 in Q4. These amounts changed quarterly growth from a -2.3% nominal decline to a 1.6% SA increase
- In third place is inflation compensation to determine the “real” growth rate. Here’s the problem. It was calculated by adjusting the GDP “implicit price deflator” of 2% (over 8% on an annualized basis). The seasonally adjusted growth rate thus fell from 1.6% to “real” (0.4)%. However, this inflation adjustment has abnormal components that are comparable to the CPI. An accurate inflation rate of 6.6% or less would erase this negative result.
Note: The Federal Reserve’s preferred measure of inflation is PCE (Personal Expenditures) excluding food and energy. For the first quarter of 2022, that rate was 1.27% (5.2% annualized). For comparison, the rate for the CPI excluding food and energy was 1.58% (6.5% on an annualized basis).
Conclusion: The optimism is coming, so own shares
This slowdown is eliminating excesses and rising interest rates are resuscitating dying growth drivers – the many areas that have been hurt by interest rates near 0%. As interest expense increases, borrowers become more sensible. And when interest income goes up, the economy will get a good boost from the holders of all those trillions of dollars in short-term assets. In addition, investors will once again have options that all yield returns that are at or above the inflation rate of “fiat money.”
All of this means that optimism is right around the corner, so it’s a great time to own stocks.