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  • Scott Poore, AIF, AWMA, APMA

If You Build It, It Will Burst

One of my favorite movies of all time is “Field of Dreams.” It depicts the story of a man coming full circle to face the failures of his past and emerging all the better for it. The budget for the movie in 1988 was a meager $15 million.

By the end of 1989, the film had grossed $84 million worldwide. Though I have a personal bias toward the film, that year the nominees for Best Picture were stout - "My Left Foot," "Born on the 4th of July," "Dead Poets Society" (a film we have previously covered on the Musings), and "Driving Miss Daisy" (the ultimate winner). The studio actually built the baseball field in the middle of a real farm in Iowa for filming. The family who owned the farm decided to keep the field after filming wrapped and, to this day, people are allowed to come play on it anytime between April & November.


One of the most famous quotes in movie history comes from this film, as a magical voice tells Kevin Costner, “If you build it, he will come.” Well, if the Fed builds it (bubble), it will eventually burst. Let’s get into what we’re seeing so far this week…


We Can Rebuild It. The good news during this volatile period is that, like Kevin Costner's character (Ray Kinsella), America will emerge stronger on the other side of recession...eventually.

In "Field of Dreams," the final scenes show James Earl Jones' character making a case for keeping the field, despite the Kinsellas bordering on bankruptcy and selling the farm. In making his case, Jones utters the line, "America has rolled by like an army of steamrollers. It has been erased like a blackboard, rebuilt and erased again." If we know anything about business and economic cycles it's that troughs are usually followed by peaks.


While we are entering the beginnings of a recession, eventually that will bottom and we will begin the climb out toward a new peak. On average, Bull markets last approximately 50 months while Bear markets last approximately 13 months. Over the past 73 years, the average return of the last 13 Bear markets is -25.8%, while the average return of the last 14 Bull markets is +136.0%. The good news from a long-term perspective is that we have a lot of history to guide us through this rough patch.


The Fed Will Burst It. While economic recessions occur naturally, the Fed is doing everything it can to push us faster toward that inevitability. We have covered at length what lead us to this economic bubble and how the Fed historically has pushed the economy into recession in previous posts.

An interesting character in "Field of Dreams" is Dr. Archibald "Moonlight" Graham. In the movie, he tells the story of missing his opportunity to play in the Big Leagues as he states, "We just don't recognize life's most significant moments while they're happening." The same can be said of the pandemic policies and Fed Balance Sheet. In 2020, people were scared out of their minds and government took advantage. The Fed's Balance Sheet ballooned by $4.7 trillion and government spending to the tune of $5.4 trillion put money in people's pockets while labor markets and supply chains were turned upside down. We didn't realize what was happening while in the moment in 2020-21.


Current futures predict a 94% probability of a 75 basis point rate hike at the Fed's July 27th meeting.

If we look at the current "Dot-Plot" of Fed Funds Rate, the Fed is projecting rates to end the year at 3.25%. That means that if this month's rate hike is indeed 75 basis points, the remaining rate hikes would add another 75 basis points on top of July's rate hike. In fact, the Fed isn't projecting rate declines until 2024. This seems illogical in light of the release of the minutes from last months' Fed meeting. The Fed remained hawkish despite comments that economic contraction was already underway. Below are some of the highlights from the minutes:

  • "Most participants assessed that the risks to the outlook for economic growth were skewed to the downside."

  • "A few participants noted that, in other sectors of the economy, their contacts reported that they were postponing investment or construction projects because of rising input and financing costs."

  • "Participants judged there was a significant risk higher inflation could become entrenched if the public questions the Fed's resolve."

Let's unpack those comments, shall we? The Fed acknowledged that there are risks to economic growth continuing to erode. In fact, the Atlanta Fed is projecting negative GDP growth for the 2nd quarter. And, they're going to increase rates another 1.5%? Some Fed members noted that their contacts (likely, major U.S. corporations) are postponing projects due to higher costs. And, they're going to increase rates another 1.5%? Those cause and effect situations do not seem congruent. The Fed is caught between a rock and a hard place, and yet the Fed is worried about the public questioning the Fed's resolve? Too late - according to a Gallup poll, confidence in Fed Chairman Powell has dropped from 55% in 2021 to only 43% in 2022.


Watch Out For In Your Ear. A funny moment in "Field of Dreams" is when a young Moonlight Graham gets to play on the magical field on the Kinsella's farm. He takes a ball close to the head and fall down to avoid being hit by the pitch.

A seasoned Joe Jackson gives young Graham some advice, "He's not gonna wanna load the bases, so look for low and away. But, watch out for in your ear." At this point in the economic cycle, we have to be aware of data as it is changing. The economic data this week has been conflicting at best. Factory Orders improved in May, despite Fed manufacturing surveys showing steady declines. The Services indices (ISM & Markit) moved slightly higher in June. However, Weekly Jobless Claims and Continued Claims disappointed once again. Weekly Claims came in higher than expected for the 5th consecutive week and Continued Claims were higher than expected for the 2nd consecutive week and 4th week out of the last 5 weeks. The Jobs Report released this morning is especially conflicting. The print for June showed higher than expected 372,000 jobs created.

However, that does not match up with the previously mentioned jobless claims and was a shock to Wall Street this morning. If we dive deeper into the report, the difference between the "establishment" and the "household" surveys is remarkable. For some background, the "household' portion of the survey is conducted by the U.S. Census Bureau, which surveys some 60,000 American households each month to determine the employment status of the individuals in each surveyed household. The "establishment" portion of the survey is collected by the U.S. Bureau of Labor Statistics, which incorporates the payroll records of some 144,000 non-farm establishments and government agencies. In this month's report, the "establishment" survey showed 372,000 jobs created while the "household" survey showed 315,000 jobs lost. This divergence is a little coincidental with the fact that the ADP Private Payroll report was delayed this week. According to ADP, they will "retool" the methodology of the report and are targeting August 31st as the next release of the new report. It is uncertain if ADP will provide data for June and July in the August 31st release. April and May's Jobs Report from the government were both revised lower for a total of 74,000 overstated jobs. The divergence between the establishment and household jobs surveys could mean that June's report gets revised lower, as well.


In addition, interest rates are swinging wildly. For the 2nd time this year, the 10-year Treasury Yield and the 2-year Treasury Yield have closed inverted (2yr > 10Yr).

This has historically been taken as a sign of coming recession. Interest rates are acting wildly in speculation of what current economic information means in terms of guessing the Fed's next move. The ICE BofAML MOVE Index is a measure of U.S. interest rate volatility that tracks the movement in U.S. Treasury yield volatility implied by current prices of one-month over-the-counter options on 2-year, 5-year, 10-year and 30-year Treasuries.

You can think of MOVE as the bond equivalent of the VIX for equities. In the past 3 months, the MOVE index dropped 27% over the course of May to increasing 53% during the month of June. Could bond yields be anticipating a pivot by the Fed to lowering interest rates later this year? That depends largely on the data. For now, the U.S. consumer is still constrained. Next week, we'll get the June numbers on inflation (Consumer Price Index). Today's Jobs Report showed that Average Hourly Earnings were flat month-over-month, but dipped again on a year-over-year basis. The projection for next week's CPI number is another year-over-year increase, which would mean that the U.S. consumer is going to feel even more pain. This will certainly affect corporate profits, and thus, the equity markets going forward.


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