Economies go through cycles
Free world economies are complex systems that balance economic and political realities in democracies. Recessions and occasionally depressions reflect declines in economic activity and political leadership invariably tries to turn the occasional minus back into a plus. It’s often only a difference of a few percent but it’s never been easy.
Over the past 120 years there have been 23 downturns that qualified as a recession or depression. Between 1902 and 1929 there were 8 and since 2001 3. Over the entire period one of these events occurred every 5 years. In the new century the time between them has increased to 7.33 years. The difference is that the Federal Reserve has continued to develop tools to manage the economy. The bugaboo of economic development has been price instability, both as inflation and deflation.
We’ll experience some of this over the next 12 months, probably sooner rather than later.
The Federal Reserve’s jobs are to keep the economy growing, encouraging the nation to full employment while maintaining the US dollar within a stable range. The dollar however becomes inherently less stable when more debt is created. It’s a known risk the Fed has chosen to ignore. During the Federal Reserve’s admirable intervention during Covid they flooded the markets with liquidity but the reason it’s not been done often has been because it is known to be dangerous. The risk has been inflation. Inflation is difficult to control, once it takes hold, because the instinct to raise prices is strong and willingness to cut is rare. I believe the Federal Reserve understands this very well, while downplaying concerns that logically flow from the evidence around us.
The question is do you believe your lying ears or your lying eyes? The Fed understands if the economy and investing community feels relaxed about further rate increases they gain time to manage rates higher in a way that doesn’t rattle the nation. It’s a neat trick that depends on the market to believe they can do it.
However, such confidence depends in part on what you encounter every day. If the price of your hoped-for new car is up, way up, pay attention. If your meals at restaurants are up - pay attention. If your water and tax bills are higher - pay attention. If you inquire about having some work done on your home pay attention. If you notice persistent evidence of inflation it’s then useful, even necessary to lower exposure to stock market volatility as the market is very close to fully valued given its current nose bleed PE [price to earnings] ratio. What is the risk? A short term 20% decline would simply bring the market multiple down into the high normal range within as few as 10 sessions. If you are using 50% leverage and the market takes a 20% hit you’ll be down 40% and will be facing margin calls. To avoid that anxiety prepare for volatility. The market has been rewarding the adventurous but into the mid-year I expect being conservative will be more comfortable.
When the market settles down then build new positions. A serious correction is overdue.
