The markets are entering the new year with stories galore and little to back them up. Inflation continues to be the primary topic of conversation, including the projected responses from the Federal Reserve Board. But, supply chains are starting to ease, along with the current variant of covid-lite both have taken, in my opinion, some of the punch away from the inflation argument. So, what’s fueling inflation?
While the increase in the demand for commodities coming from both industrial the technology sectors is real as expressed in the demand for infrastructure and semiconductor stocks, even that will eventually ease. The Employment Cost Index, which tracks wage compensation inflation, has been steadily rising to levels not seen since before the financial crisis. More money earned, more money to spend. And that spending as a Percentage of GDP, has been steadily rising to the highest level, 69% in 2021, in over 70yrs. Add to that, supply chain challenges to demand, and it’s easy to understand where some concern is coming from.
So, in my opinion, the more aggressive tone from the Federal Reserve regarding interest rate hikes as the weapon of choice to fight inflation is one of genuine concern, with one caveat. The concern comes from the historical precedent that began in the 1980’s when Paul Volker, the then current Fed Chairman, raised interest rates in order to slow the economy and thereby curb inflation. Essentially, people spend much less during a recession. However, it was not as smooth as expected as interest rates needed to rise not by a quarter (.25%) percent four times as projected in 2022, but by over 5% in 1980 alone taking the 10yr Treasury to over 15%, currently 1.71%. Hence the fears that are infecting the markets.
So, the recent declines in the broad indexes are a product of both those aforementioned fears and a condition that was by definition overbought. But the overbought condition is beginning to ease with each sharp decline and it’s especially the growth sectors, such as Consumer Discretion and Technology, that are taking the brunt both fundamentally and technically. In my opinion, the current volatility is buffering the models, with both cash and some favorable sector exposure in addition to the less favorable. Overall, the diversification is keeping the performance in line with benchmark targets and for now, only patience and some opportunity buying makes more sense than listening to the self-proclaimed experts.
My reason is simple, if the markets correct enough, it would be the first time since the beginning of the pandemic, and many of the Pindudes, namely the newcomers and other recently brainwashed speculators who got very lucky in the thick of the pandemic and its variants, will likely lose some enthusiasm and two things may happen, they will have less discretionary capital to spend, good for inflation, and they may actually look for a real job, also good for inflation. In the meantime, when the market goes to oversold, Algochums and Hedgefiends will buy, Maybe it’s not the best road to get there, but an outcome that would make a recession, in my opinion and I hope the Fed’s opinion, an unnecessary option.