The Federal Reserve And The Bullwhip Economy

The Federal Reserve And The Bullwhip Economy

June 29, 2022
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Over the past few weeks, the economic indicators have been showing that the fear of inflation seems to be easing. As all financial news followers should know, the Fed’s primary mandate is to sustain an orderly economy. This means inflation on a slow-growth level, and the US Dollar steady relative to foreign currencies, gold, oil, and general commodities. About this time last year, Fed Chairman Jerome Powell made it clear that he was going to wean the economy off of record-low interest rates and bleed off the excess cash that has been sloshing around. So far he has done a good job putting a dent in copious consumption, skyrocketing real estate prices, and unbelievably high rental rates by raising the Fed Funds rate.

As of last week, this is what we seem to be checking off:

  • Industrial metals are declining in price (copper has had the greatest decline)
  • Agricultural commodities are stabilizing and trailing off (even with no de-escalation in the Russia-Ukraine conflict)
  • Retailers are sitting on record inventories- this seems to be kicked off by an announcement from Target.
  • Housing inventories are at multi-year highs.
  • Some home listings are being discounted (fury buying has been the norm for a couple of years)

It may be true that prices are not showing runaway inflation, but instead, we are now beginning to experience what we call a “bullwhip” economy. I say bullwhip because of the way things seem to be panning out this time.

This is the progression that we have gone through and where we are now:

  1. After the Great Financial Crisis of '08-'09, the Fed instituted various forms of Quantitative Easing (QE). It did this by lowering interest rates and fueling the economy with money. They monitored the negative effect of these by following the US Dollar stability and that of general gold and commodity prices. All were pretty stable.
  2. Then they tried to slow up the economy a bit in 2018 by raising rates and this didn’t seem to work out so well as the economy really didn’t want to deal with a slowdown and a broad correction ensued. Temporary, but still kinda painful.
  3. Then came COVID, and with it a complete global shutdown as the world tried to cope with the closing of what seemed to be all businesses. The Fed came to the rescue, dropping rates to zero and putting the money printing press in hyperspeed.
  4. The effects of too much money manifested in huge speculation in crypto, speculative companies, and general price levels of goods and services.
  5. Fed jumped in and said this can’t continue and proceeded to slow things down. They are still in this process today.
  6. Supply chain issues continued in China (cutting off supplies of many things most well-known being semiconductors) and Russia invades Ukraine and shuts off food and energy to Europe.
  7. Retailers and manufacturers doubled and tripled orders to make sure they were getting enough and this put further pressure on prices and interest rates.
  8. Stock markets came back to earth and now sit at more normal levels. See below:

 

As can be seen above, the corrections that we have experienced have truly been painful, yet not uncommon. What was uncommon was the run from the March 2020 COVID lows to November 2021 market highs was the fastest double the S&P 500 has ever experienced. Hence, the rate of the pullback that we are experiencing is happening very quickly as well. At the same time, and different this time as well, the bond market has experienced a painful pullback as well. Never have bonds gotten hit as stocks have (see below).

The key to market recovery remains economic data, quality of revenue and earnings in Q2, and any evidence that the Fed is on the right track to getting inflation in check in the quarters ahead this year and next. Powell is trying to take this massive economy of ours and orchestrate a soft landing where we don’t recess, but instead, effectively burn off the excesses in the economy while keeping unemployment from rocketing.

Last week, economic data began to show enough evidence of slowing in business and consumer activity to suggest that the Fed might not have to be as aggressive going forward as some had feared earlier in the week. A Fed head- Bullard changed his tone from aggressive tightening to concern about a possible recession. He stated the balance between these recession fears vs. a consumer still flushed with cash and household gains from real estate prices.

I am following the 10-year Treasury yield, which got tired at 3.5% and is backing off, showing the growth of the economy is tapering off. I am also following economic indicators showing consumption trailing off but capital goods pricing is still firm (but not too hot). I am going to be following earnings for the second quarter which will begin in another week to see if the forecasts for the rest of the year are still healthy. And last, looking for opportunities in great companies that have probably been repriced too low (see the chart Nasdaq Futures) and should be the biggest beneficiaries of slower growth (translates as manageable) economy. Because it is the midterm year, the fourth quarter should be good after the digestion is over (see Bad Starts To a Year At Halftime Don’t Always Mean More Trouble chart below).

 

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