The shifting of responsibility from the individual to the collective, i.e., the government, usually happens at a crisis. First, government steps in, then, after the crisis, steps back... but never as far as it was before the crisis. It then needs resources and gets them from individuals, i.e. taxes, which hurts growth. COVID-19 presented that crisis, the election furthered the administration’s reaction, and this is the backdrop that the Federal Reserve must deal with the greatest inflation since the Reagan administration.
Inflation is an extremely regressive tax on the lower incomes that are using their current income to just get by. That creates political incentive for the administration and Congress to add fuel to the flame of inflation by further stimulus or government “assistance” programs. The Fed “taps the brakes” on the economy by raising interest rates to slow down demand.
Midterm election odds indicate Democrats will lose the House while the Senate looks up for grabs. That puts a sense of urgency on the White House to get whatever victory it can before it is too late.
The Fed has two tools in the spotlight at its disposal. Media coverage focuses on the short term fed funds rates. We expect them to top 3.5 percent mostly by year end. But just as effective is the Fed’s balance sheet, where rolling bonds off influences longer term rates. At this writing, the 2- and 10-year rates have ever so slightly inverted inside a steeper, but still mostly normal, yield curve. Can inversion be far behind?
Chairman Jerome "Jay" Powell has said that inflation is his singular focus. He is determined to orchestrate a “soft landing,” i.e. bring down inflation while keeping employment intact and not causing a recession. That is a tough thing to do and rarely accomplished. However, he has the strongest job market in many years with two jobs open for every job seeker and a supply chain that is beginning to open up, a worldwide pandemic that is becoming more manageable, a war in Ukraine that must end sometime and a population running out of excess spending money created by stimulus payments. Sorting out what is temporary versus permanent is his first task. Understanding the demeaner of Congress to give out money and/or to tax is the second.
Those watching this Kabuki theater for market affects are enduring the volatility that goes along with it. The market has declined 20 percent. We have already seen 98 percent of the normal market decline of a mild recession. Yet, earnings have continued to rise, making the S&P more attractive at a P/E of 15.9 versus the over 20 of a few months earlier.
You must ask at this point if you are an investor or a trader. Traders are looking for an entry point in an attractive market searching for a sustainable bottom. Don’t wait only to find it in your rearview mirror. Investors remain fully allocated and invested at this point with a longer view. Whichever you are, it appears that we are much closer to the bottom than the top of this market.
We wish Chairman Powell the best of luck.
Jim Saling, CIMA®, CPWA®,CPFA®,AIF® is the president of Saling Simms Associates, a registered investment advisor and a longtime supporter of both OSAP and the OSAP Foundation. Saling Simms Associates serves as OSAP's titanium sponsor throughout the year and its annual conference platinum sponsor.