In the first Matrix movie (1999 vintage), a black cat crossing a hallway triggers a case of déjà vu for Neo. It was a sign that something was amiss … and that things were about to go downhill fast.

Now I’m having my own episode of déjà vu … and maybe you are too.

Because it all sounds too familiar.

COVID striking the heart of a key industrial hub in China. The Chinese government locking down millions of citizens to prevent the spread even further.

The cascade effect goes on to wreak havoc on supply chains, disrupting key ports and shipping activity.

That’s not a recap of 2020 … that’s the latest news from this Sunday.

The highly transmissible omicron variant is challenging China’s zero-COVID policy, forcing the government to shut down broad sections of its country … and its economy.

We’re talking about a key tech hub supplying the likes of Apple, a region that’s home to China’s second-busiest port.

And it couldn’t come at a worse time … for the economy or the stock market.

A Historic Lag

This week’s report on producer prices already showed a 10% gain in February from last year’s levels … tying January for the highest reading ever.

And now the latest developments in China are just another supply-chain crunching, inflation-stoking catalyst that the Federal Reserve will consider as it concludes its meeting today.

Not only is the Fed expected to increase interest rates for the first time since 2018, but a new summary of economic projections will give insight into the expected path forward.

This comes at a time when the Fed is behind the curve, perhaps by the most ever. The chart below shows the difference between the Fed funds interest rate and realized inflation.

Never before has inflation been this high with interest rates so low.

(Click here to view larger image.)

That should give rise to concern for your stock portfolio. Here’s why.

The “R” Word

“I would hope history will record that the answer to your question is yes.”

That was Fed Chairman Powell’s response on whether he would take action to reduce inflation at all costs … implying he’d do so even if that meant tolerating a recession.

Last week, I told you how the Fed could sow the seeds of destruction for commodities markets.

Turns out, the Fed may do the same to reduce aggregate demand in general — via a recession — to stamp out inflation.

Here’s What It Means for You

With the S&P 500 falling into 10% correction territory, analysts at Goldman Sachs looked at what happened next historically.

In the past, when the economy avoids recession over the next 12 months, it’s a tremendous buy-the-dip opportunity. That’s because the stock market goes on to recover its losses on average.

However, if a recession is around the corner, then the stock market has historically plunged to new lows.

If you want to know the early warning signal I’m watching for a recession, be sure to check out my commentary here.

Otherwise, be sure to check out Ted’s Friday video where he’ll deliver his take on the Fed’s meeting and the implications for the stock market and your portfolio.

Best regards,

Clint Lee
Research Analyst, The Bauman Letter