The Fed’s Scared … and You Should Be Too
- The Dow Jones Industrial Average jumped 300 points on hopes of rate cuts.
- We saw the same thing in 2007 — right before the financial crisis.
- The Fed’s scared of another recession. And we may already be in one.
First, I just want to say I’m sorry.
I didn’t want it to happen this way.
We’ve been here before, and I was hoping we wouldn’t return.
We’re in “Backward World.”
What is this, you ask?
It’s when the market goes up because of the weakness of our economy.
OK, now that I have your attention, what the heck am I talking about?
I’ll explain. Read on to learn what this means for your portfolio…
We’ve Seen This Before
Here’s what the CNBC headline said:
I understand many were applauding headlines such as this last week. But I wasn’t one of them.
It’s not that I don’t want the market to go higher. I do. But I want it to go higher based on its fundamental strength, not its apparent weakness.
It’s tough to get excited about a weak jobs report.
But we’ve seen this before.
During the market sell-off in the late 2000s, the Federal Reserve eventually started cutting rates in 2007. It cut them to zero by the end of the next year.
It was trying to spur the economy. To help encourage the banks to keep lending. To help people get out of their underwater real estate loans.
To help us avoid the downfall we had brought upon ourselves.
The 2015 film The Big Short, based on Michael Lewis’ book, showed how the U.S. had messed with the system. And the result was the financial crisis.
(I recently watched it again and highly recommend it … especially if you haven’t seen it. It may surprise you to learn how our financial system works.)
That was a scary time. The S&P 500 Index closed at 676 on March 9, 2009 … a level it hadn’t seen since 1996.
It’s Different, But…
Back then, we were facing one of the worst economic scenarios since the Great Depression.
Our situation isn’t so perilous today.
We have more jobs available than we have people to fill them. 1.63 million more.
In April, hirings grew to the highest level since the Department of Labor started tracking them in 2000.
At nearly 2,900, the S&P 500 is almost as high as it’s ever been.
Yet we aren’t operating from a position of strength.
The Fed suggests it may be willing to cut rates soon.
That’s not great.
The financial media are calling these “insurance” cuts. One article I read said they “would theoretically provide a buffer against any economic weakness caused by an ongoing trade war and tariffs with China,” (italics mine).
And our stock market has already priced in cuts. Since bottoming on June 3, stocks gained more than 5% in five trading days.
Everyone loves cheaper money.
Don’t let everyone fool you.
A Fed that’s coming to the market’s rescue?
The Fed doesn’t like to play that game. Especially when President Donald Trump tells it to. The Fed doesn’t want to be anyone’s patsy.
It’s considering cutting rates because it’s scared.
The Fed has two areas of focus: inflation and unemployment.
It has an objective of maximum employment. That’s going well. We don’t have enough people to fill the open jobs we have.
Of course, we’d like to see job growth increase faster. But we’re OK here.
The Fed’s other objective is stable prices. It seeks inflation at a rate of 2% over the long run.
That hasn’t been working so well.
The Market’s Catch-22
The Fed’s preferred method of measuring inflation is the annual change in the price index for personal consumption expenditures, or PCE. It measures individuals’ consumption.
The PCE is reported every month.
In the last 10 years, the Fed has only recorded a 2% increase six times. Six times out of 120 data points.
The Fed isn’t achieving its goal of stable prices.
And now the market believes it will cut rates.
Based on the big upward move in the market, at least one cut has already been priced in.
Rate cuts make things cheaper to buy with borrowed money. The market likes them. But when it’s priced in, the eventual cut itself won’t move the market higher.
The market will only move higher if there are more rate cuts than expected.
But that’s the Catch-22.
If the Fed cuts rates more, it’s because it’s worried about the economy.
If it’s that worried about the economy, we may already be in a recession.
Be cautious here.
The market has been zooming higher.
It’s great that investors were able to recoup some or all of May’s losses.
But the market isn’t moving up because it’s strong. It’s moving up because the Fed is worried the economy is weaker than it wants it to be.
Enjoy the temporary upswing, but be wary. Geopolitical tensions and trade wars are on people’s minds.
It would help to resolve the China situation. But you should be prepared if it languishes further.
You should also be realistic. Hopes of more rate cuts may make the market jump higher in the immediate term, but “Backward World” isn’t the panacea that will lead to sustained higher stock prices.
From 2007 to 2009, the Fed cut rates 10 times. I don’t think it’s ready to go that far yet.
As always, be selective about your purchases. Set stops on your positions … and honor them.
Editor, Insider Profit Trader