In the 1980s, "goods" inflation peaked when the Fed, under Volcker, broke the back of inflation. Today, as opposed to back then, we can see virtually everything in an instant to evaluate the actions of the Fed. Powell stated that his desired goal was to rein in inflation at a “measured pace.” The Fed doesn't want stocks to fall, but they want to tighten financial conditions. There is simply no way for the Fed to stabilize the financial markets and take the economy off the sugar high without some level of headache. I believe that the Fed knew that there was going to be some level of pain, yet they were truly focused on not creating a "hard landing."
In today's note, I will give some explanations of where we are as well as some comparative graphical representations of where we are compared to what we experienced the last time we had a major inflation scare, the 1980s.
Historically, inflation moderates when the prices of "goods" begin to decline. When I say "goods" I'm referring to durable items, apparel, cars, furniture, and other bigger items. As we all know, the supply chain has been accused of being the culprit of price spikes in these durable items. This may be the case, but the point is that the prices spiked, people kept on buying and therefore the prices became sticky and stayed at elevated levels.
Now, with market-driven interest rates spiking along with fuel and food prices more than doubling, the demand has come to a manageable level or, in some cases, a screeching halt. The toughest action to take when analyzing this data is to ignore the media-induced noise and remain focused. When we look back at what we have been dealing with in 2022 thus far, it has been one rain cloud after another. All of them have led to increased market volatility and a level of correction that has not been seen in many years.
And to address how the "goods" picture is being addressed, and how this time is different, take some time and examine the INVENTORY chart below. As soon as the supply chain opened back up (when China ended their lockdown and their ports reopened) inventories began flowing freely once again.
What this picture seems to be telling me is that just as things spiked as quickly and aggressively as they did, they can also reverse just as aggressively. The clue that I am looking for is in the homebuilding sector. I look at this area as it is most sensitive to changes in pricing and interest rates on mortgages. In speaking with the owner of a mortgage company this week, conventional loans have gone from less than 3% to over 6% in a period of just three months! I can't express enough just how monstrous a move this is.
Furthermore, he explained that they company has already been through two rounds of layoffs in as many weeks. Last week, the company gave notice to many workers who were refusing to come into the office. Then, it was able to further decrease its workforce this week with redundant staff as the demand for refinancing and new purchases have decreased dramatically.
Home prices, which tend to lag the mortgage volume, are also showing signs of flattening and even declining in many areas. I often explain to people that homes are, to a great extent, purchased based on the monthly cost, not the price tag of the home. The price tag of late has been the reason for shopper sticker shock. The monthly debt service is a real expense that is in place for years to come.
And remember, given the size of our national debt, every one per cent increase in interest expense at the Federal level is an additional $568 BILLION in interest expense to the Federal Government. This is a real number. This brings me to the most important point of this week's note. The equity markets are all built on expected revenues and earnings of companies (e.g. GDP). If the GDP is growing and companies have become cheaper or considered a value, then equities should be done declining and a continuing advance should ensue. I am not going to say that it happens tomorrow or this week, but we have experienced a measurable decline, and it would not surprise me to see "goods" prices and inventories stabilize and along with these markets stabilize.
Demand should moderate, layoffs should ensue, prices should stabilize, and inflation should moderate. Before this is all completed the equity markets of the world should begin to recover. Remember, the stock market is a leading indicator / a discounting mechanism of economic things to come. Just as it put in a top in November through the first week of January and has sold off.
It should be clear to everyone that this is a far different market than what we had grown accustomed to over the past several years where the Fed would always be there to save the day. But remember, the Fed has the rule book and the printing press. I don't think that they want to add liquidity, but they could very easily create policies to direct investment from corporations and incentivize them. A new history is being written. Work hard, save your money and love your family and your faith. Everything else should take care of itself.
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