Don’t be fooled: investment risk is not rewarded

Once again, a few days of bullishness brought stock market optimists out of hiding. But don’t believe their claims that the 2+ month downtrend is over. The market has simply moved up relative to the 200-day moving average – a common “test” of measuring long-term trend.

So this is likely an investor trap that causes nervous investors to hold on and aggressive investors to buy more. If this is the case, the stock market will eventually fall again and test new lower levels.

(And remember: This stock market is still underwater from its December 2021 highs. The erroneous belief is that the 2022 bear market is over. However, until this market hits new highs – it (i.e. new inflation-adjusted highs – it remains in falling market territory.)

But what about the good news that rising interest rates allow the Fed to reverse course?

It is the return of vigor to the capital market that is pushing rates up. The proof is the daily rise in U.S. Treasury auction bids by licensed Wall Street firms, even as the Fed remains on the sidelines. Two this week are particularly noteworthy:

• Wednesday October 11 – The closely watched US 10-year bond yield offering was 4.61%.
• Thursday, October 12 – The longest yield bid on 30-year U.S. bonds was 4.84%.

Clearly, Wall Street no longer expects a rapid return to the 2% inflation rate desired by the Fed.

This is good news because it proves that the Fed’s misguided multi-year strategies are coming to an end. And that means an end to overindebtedness strategies, misdirected capital flows, inequitable reductions in interest income, and the Fed’s timid “fight” against inflation.

These negative issues have not been lost on Wall Street, bankers, and the many other entities that have faced abnormal actions and repercussions. They are therefore happy to join the welcome party for the return of traditional capital markets.

There is other “good” news: a recessive readjustment

While capital markets react freely to current conditions, there remains the widespread and disjointed actions caused by the interest rate and money supply machinations driven by the Fed for 15 years. These anomalous effects are always anchored in the components of the economy, in the composition of the financial system and in the minds of consumers and investors. Only a recession can produce the corrective consequences needed to undo these effects – for example, hyperleveraged companies, organizations, and asset funds that wrongly expected the Fed’s low interest rate policy to continue. a long time.

Will there be attractive investment values ​​from the hubbub?

Yes, but not before things get complicated, ugly and scary. In other words, not until our stomach says, “No, of course!” Good reading is The Wall Street Journal, heard on the street article on small businesses: “These stocks cry recession. It’s almost time to buy them. » (Emphasis mine.)

“Over the past 11 recessions, a small-cap stock index maintained by MSCI
MSCI
like large caps beaten over 12 months after a recession was declared each time, leading them by 16.51 percentage points on average.”

As we know, no recession has been declared. Quite the contrary, the pendulum has swung again, now towards the idea that a recession has probably been avoided. In other words, if a recession is coming (and conditions still point to that outcome), the time to buy small company stocks remains in the future.

Potential Congressional reshuffling of Federal Reserve guidelines

The 2024 presidential election draws appropriate criticism of the Federal Reserve’s goals and actions. We must therefore expect significant changes which will allow the Fed to no longer intervene in the capital markets in normal times to achieve the objective of “full employment”. The Fed’s most important roles remain ensuring a healthy banking system, a strong currency (Federal Reserve Notes), and a “lender of last resort” to prevent or cure financial panics.

For many years, Congress has accepted and approved the independent actions of the Federal Reserve. However, there is now a public debate, particularly among Republican presidential candidates, about the possibility of changing the Federal Reserve’s guidelines.

To understand the criticisms and potential changes ahead, here are the main goals currently driving the Federal Reserve’s actions. (The San Francisco FRB has a more complete explanation in “What is the Fed: history.”)

• In 1913, Congress created the Federal Reserve. Besides monitoring the banking system, an important goal was to prevent or thwart financial panics by being the “lender of last resort.”
• In 1977, Congress added price stability as a goal
• In 1978, Congress added full employment as a goal

A recent Yahoo finance interview of former Vice President Mike Pence lays out his criticisms, which are also shared by other Republican candidates:

“Pence…said the Fed was ‘catching up’ after keeping rates low for too long. He also renewed calls for the Fed to end its dual stability mandate prices and maximum employment, saying the Fed should only focus on keeping interest rates stable and fighting inflation.

“’Full employment should be the business of the president, members of Congress, governors and elected officials,’ Pence added.

Regarding Federal Reserve Chairman Jerome Powell, Pence said: “We need new leadership at the Fed that is going to step up and join us in an effort to actually fight the warring inflation to American families. »

And Pence is far from alone in his disapproval of Powell as head of the Federal Reserve. GOP rivals, including former President Trump, Florida Gov. Ron DeSantis and entrepreneur Vivek Ramaswamy, have all targeted Powell during the election campaign, signaling their desire to replace him when his term expires.

The Bottom Line: The Current Federal Reserve Has Created Problems It Cannot Solve

The Fed has made mistakes before, but never this big, this long and this pervasive. So the question is: what kind of recession is needed to fix it?

Simply put, the answer is that it must be real. This means the economy (spending and production) slows, unemployment rises, the financial system tightens, and weak businesses and organizations are restructured, bought out, or closed.

What about inflation? That is the uncertain question. Neither the major recession of 1970 nor the terrible recession of 1973-1974 could control the inflation cycle that began in 1966. It took the double recession of 1980 and 1982, led by a president of the Very severe Fed, Paul Volker, to break his back.

Therefore, the best investment strategy remains to hold more than 5% of interest-producing money market reserves.