Crushing Reality - MMM v3-34

"We will keep at it until we are confident the job is done......While the lower inflation readings for July are welcome, a single month’s improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.......In current circumstances, with inflation running far above 2 percent and the labor market extremely tight, estimates of longer-run neutral are not a place to stop or pause.....Households and businesses may feel some pain, but these are the unfortunate costs of reducing inflation, but a failure to restore price stability would mean far greater pain....."

Those were some of the highlights from Fed Chair Jerome Powell's speech at the annual monetary policy symposium at Jackson Hole. With just a few phrases, Chair Powell squashed the primary driver that took the stock market up 18% from the lows in July. Most people cheering the rally believed the Fed was close to done with their interest rate hikes, with some projections calling for reduced interest rates next year.

I have been adamant in this blog and on social media that this thought process was a mistake. Last week I said it was dangerous to believe the Fed was bluffing.

Just a bluff? - MMM v3-33
The Federal Reserve has been going out of their way to tell the stock and bond market that they will be focusing solely on taming inflation and won’t be looking to stimulate the economy unless inflation is under control. Too much money floating around the system led to too much
The Federal Reserve has been going out of their way to tell the stock and bond market that they will be focusing solely on taming inflation and won't be looking to stimulate the economy unless inflation is under control. Since mid-July, the stock market has ignored their warnings. It's as if the market believes the Fed is bluffing and won't follow through with their plans. I think this is a dangerous bet.

It is not worth our time to try and guess what the Fed may or may not do. Here are the things we know for a fact:

1.) The Fed WANTS slower growth in order to curb inflation.
2.) Stocks are priced for continued strong growth.

Markets and economies move in cycles. For most of my career I've highlighted how the Federal Reserve has created much bigger cycles, both up and down. Just like the past expansionary bull markets, the Fed stimulated far too much for far too long. Now they need to cause a recessionary bear market to pull back the speculation that risks disrupting the entire financial system.

Let it play out. Until proven otherwise by the DATA proves otherwise, we are in a bear market (not some Wall Street 'experts' or talking heads telling us what to think). Remember my Bear Market Tips:

Bear Market Tips - Market Musings
The media has declared stocks are in a bear market. What does that mean? Should we be worried? What should you do if this is a bear market? How is SEM positioned for a bear market? Watch the short video below for answers to all of these questions and more.
1.) Don't panic – we planned for this
2.) Ignore the media – both up and down
3.) Be patient – opportunities will emerge near the actual bottom

This has been the key to our success for the past 30+ years.

Spending more than they make

I've said throughout the year fall will be the time where we see how strong the economy truly is. We are near the end of "revenge vacation" season (I don't care how much it costs, I haven't been able to vacation for two years and we are GOING!). Credit card bills will be coming due. Budgets will be strained. Families with children will discover they have to pay for school lunches for the first time in two years (at much higher prices based on our school district.) Stimulus checks are spent and/or savings accounts have diminished.

Last week we received a few key data points from July. Consumers continued to spend at a crisp pace (+8% from a year ago):

However, income is DOWN (4% when adjusted for inflation) and we are sitting just above the levels we saw just before COVID shutdown the economy.

Families continue to spend more than they make. This cannot continue indefinitely.

On the inflation front, the Fed's preferred measure of inflation shows barely a dip in overall inflation. I find it fascinating that for nearly 20 years the Fed did everything possible to get inflation UP to their preferred level of 2%. Note the 10 and 20-year average are still sitting at that level, but the 5-year average is all the way up to 3.1%. Remember, their target is 2%. They have a long fight ahead to get it down there.

Stock and Bond Chart Updates

I continue to use this chart to keep things in perspective. The notes are key Fed related events for reference. Whether you want to admit it or not, the Federal Reserve has been the primary driver of the booms and busts in the market since the Financial Crisis. They pump money into the "financial system" (Wall Street banks) to "stimulate growth" and then they pull it back to "slow speculation". Due to deregulation the Fed isn't simply giving easy money to a bank which will then lend it back out, but instead a financial conglomerate who can do as it pleases. It is much easier and lower risk to put the money to work in the financial markets than to lend it out.

This year we've seen several "mountains" form on the chart as hope formed that the Fed might not be so serious about taming the inflation they fueled. This has been followed by the crushing reality that maybe they are taking their primary "price stability" role seriously this time. The market is still well above where it was at following the first 3/4% rate hike. It may attempt to stabilize somewhere in this range based on past patterns.

Either way, until the Fed is officially DONE fighting inflation, we should expect volatility which makes it especially dangerous to take a stab at finding the bottom.

This S&P 500 chart highlights the major adjustments our systems have made inside our models. Our longer-term trend systems in AmeriGuard and Cornerstone first sold in late February at 4300 and have been fully bearish since March 7 at 4180. While the big rally since mid-July has made these signals seem less effective (with hindsight) the key takeaway is how much volatility (angst) they have helped mitigate.

Neither trend system got sucked into the rally because there has been little volume (participation) behind it. We were inching closer to a buy signal and probably would have had one with one more up week for stocks, but we remain 'bearish' in AmeriGuard and Cornerstone, which means minimum equity allocations (30% in 'Balanced' and 70% in 'Growth'). Our economic model remains 'Bearish" as it has been since early April when the S&P 500 was just under 4600.

The most active systems have been our High Yield Bond ones. Note on the chart Friday closed out the latest attempt to find a short-term bottom. Looks like we came out slightly ahead on the trade and will again wait patiently for the next sign of a tradable rally in high yield bonds.

Turning to interest rates, I've said all year the bond market was screaming to the Fed that they need to take inflation seriously. After the first 3/4% rate hike in June it appeared the bond market felt comfortable that the Fed finally was doing their job. Since the last Fed meeting (the one where stocks decided the Fed was very close to ending their rate hikes), we've seen interest rates move up significantly. Even after Powell's speech on Friday we didn't see much movement in long-term rates, which tells me the bond market wants much more than words to be convinced inflation will be taken seriously.

I like to share my bond market trend snapshot occasionally to give us an idea of the overall bond market. A month ago the entire bond market appeared to be in rally mode. Now there are very few pockets of strength.

Patience continues to be the key.

Follow us on TikTok or Instagram

For the past month we've been posting more frequently on TikTok and Instagram. Our goal is to reach a wider audience of our future clients to provide something our country is lacking – financial literacy. We also know people's attention span has gotten shorter, so we need a more concise message.

Here's an example of a video we shared last week:

@finance_nerd 5 tips for long-term investing success. #investing #behavioraleconomics #tiptuesday #greatdane #dogsoftiktok #danesoftiktok #financetiktok #WorldPrincessWeek ♬ original sound - finance_nerd

If you're on either platform, you can follow us here (and look for a "Musings Minute video later Monday morning):

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New Kent, VA
Jeff joined SEM in October 1998. Outside of SEM, Jeff is part of the worship team at LifePointe Christian Church where he plays the keyboard and bass guitar. He also coaches a club soccer team.