Might As Well Face It...We're Addicted To The Fed
The Fed has the ability to move the markets these days with a sneeze or a cough from the mouth of Chairman Powell.
Does the Fed really want to stamp out inflation, or are they trying to control asset prices, or both? It reminds me of the Robert Palmer hit, "Addicted to Love." Palmer recorded the song in 1985, but it didn't get airplay until 1986. There's actually a good bit of trivia on this song:
Palmer wanted to record this song as a duet with Chaka Kahn, but her label wouldn't allow her voice to be used. Instead, she recorded a duet with Steve Winwood on his hit "Higher Love," which beat out "Addicted to Love" for the 1987 Grammy for Record of the Year.
Elton John lyricist Bernie Taupin claims that the video with Palmer and the models appearing to play instruments was an homage to John/Taupin's hit "Bennie and The Jets" which describes a futuristic rock ban of androgynous beauties.
The models in the video were largely unknown and just getting started. None of the girls knew how to play a single instrument and were all moving to their own beat during the video. One model, Mak Gilchrist confessed to accidentally stumbling during one take and accidentally hitting Robert Palmer in the head with her bass guitar.
In a 1992 Roseanne episode "Mommy Nearest," Jackie (Roseanne's sister played by Laurie Metcalf) lies to her boyfriend and claims to have been one of the models in the "Addicted to Love" video.
"The lights are on, but you're not home
Your mind is not your own
Your heart sweats, your body shakes
Another kiss is all it takes
You can't sleep, you can't eat
There's no doubt, you're in deep
Your throat is tight, you can't breathe
Another kiss is all you need
Whoa, you like to think that you're immune to the stuff, oh yeah
It's closer to the truth to say you can't get enough
You're gonna have to face it, you're addicted to love"
Here's what we're seeing so far this week...
You're Gonna Have To Face It, Markets Are Addicted To The Fed. So far this year, markets have traded all over the place in the few trading days of 2023. Of the 8 trading days so far this year, 4 have included wild intra-day swings from gains to losses, then back to gains all in a single day.
Why is that the case? Because the Fed is being ambiguous - hawkish one minute, semi-dovish the next. The Fed is pulling the strings on the market like Robert Palmer pulling on the listener's heart strings. That brings us to the next question - what is the Fed really trying to do with their monetary policy? We would argue that the Fed is not merely trying to control inflation, but asset price appreciation. For example, several Fed speakers and Powell himself have stated that they need to see "substantially more evidence of lower inflation."
Well, maybe the Fed's "mind is not their own" and they should peruse their own website of economic data - FRED (St. Louis Federal Reserve's website). According to the Fed's own data, the Consumer Price Index (CPI) has declined for 6 consecutive months! In fact, the current decline in CPI on a year-over-year basis is the 3rd fastest decline from peak after 6 months. The fastest was in 2009 when CPI peaked at +5.5% and fell to -0.1% after 6 months. Currently, CPI is +6.5%, down from +9.1% back in June of last year. Instead of fighting inflation alone, we believe the Fed has opened the playbook designed by past Fed Chairman Ben Bernanke when he coined the term "Wealth Effect" in 2003. In Bernanke's own words:
"Easier monetary policy, for example, raises stock prices. Higher stock prices increase the wealth of households, prompting consumers to spend more–a result known as the wealth effect. Moreover, high stock prices effectively reduce the cost of capital for firms, stimulating increased capital investment. Increases in both types of spending–consumer spending and business spending–tend to stimulate the economy."
Easy Fed policy got us into this mess (along with ridiculous Government spending during the pandemic). Overly restrictive Fed policy to correct mistakes made during the pandemic has led to the market declines over the past 12 months. Influencing stock prices, through tools and hawkish/dovish language, helps the Fed accomplish their goals - which does not include helping the "little guy."
The Lights Are On, But They're Not Home. Human behavior is a fascinating thing. We have just suffered through a general decline in the markets of approximately 18% from the highs (using the S&P 500 as a barometer).
History shows that equities do not suffer back-to-back negative years very often. The past also shows us that fixed income has only suffered back-to-back negative years twice. And yet, 23 of the largest banks are calling for a recession this year. If anything, the data is inconclusive at best. While real estate and manufacturing are still at low points, the overall health of the economy is still stable, due in no small measure due to the consumer. We'll get the updates on Retail Sales, Manufacturing, and Housing Data next week.
For the time being, December's CPI that was released today was much lower, as expected. This caused expectations for February's Fed meeting to result in only a 25 basis point rate hike. In fact, one commentator, Nick Timiraos, who has been tabbed the Fed's Wall Street Journal mouthpiece, is saying the February rate hike may be a "one-and-done" scenario for 2023.
This is yet further evidence of the Fed's double-speak on rates. Meanwhile, the Chicago Fed's Adjusted National Financial Conditions Index (ANCFI) is showing financial conditions as easing. Right now, that index is showing a reading of -0.26, as compared to a positive reading (which is bad) back in June of 2022. From a technical standpoint, the fear element of our Wealth Protection Signal, the TED Spread, has finally broken out of its range-bound action of the last 4 months. On Tuesday, the TED Spread dropped to a level of 24.1, which is the lowest its been since September 13th, 2022. We'll see if this translates into the Wealth Protection Signal hitting a level recommending a "fully invested" status.
It's Closer To The Truth To Say You Can't Get Enough. While Mr. Timiraos may indeed be a mouthpiece for the Fed, we expect more back-and-forth from the Fed.
Even if February proves to be the last rate hike, we'll never know until the Fed is ready to provide that little revelation. Investors should not get overly excited about going all-in on equities. However, now is the time for longer-term investors who can handle some risk to start putting some dry powder to work. The S&P 500 Index is up 14% from the October 13th low of last year. And yet, equities are still down 16% from the high on January 4th of last year.
Even if investors tip-toe into equities now, and markets retest the October 13th low, buyers will be positioning at a 16% discount, with the prospect of higher returns when the Fed eventually takes their foot off the brakes. When the Fed does take its foot off the brakes, expect markets to move higher, which, ironically, will further make markets more dependent upon the U.S. Central Bank. There is also the historical context of how markets perform during the 3rd year of a Presidential cycle. Less to due with politics and more to due with legislative cycles and midterm switches in controlling party, the 3rd year of a President's term typically signifies a slow down in policy changes. Markets like a stalemate in D.C. Since 1949, the 3rd year of a President's term has provided positive returns almost 89% of the time, with the average return being +16.78%. In those few instances where a negative return results, the average downside is -0.36%. In 1988, Tom Cruise entertained a generation by throwing whiskey bottles into the air, while dancing, and reciting poetry. In that movie, "Cocktail," there was a scene where Brian Flanagan, played by Cruise, makes cocktails while singing Palmer's hit, "Addicted to Love." Perhaps Cruise is right - "your throat is tight, you can't breathe" - but, in the end...might as well face it, we're addicted to the Fed.
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