Markets are lost in a fog of interest rates and the Fed is largely responsible. It's somewhat reminiscent of 1969...or, is it? The current trajectory of equities has been lower, but is that justified given the backdrop of economic data?
The inspiration for this week's musings is the 1984 song, "Summer of '69." I don't know if you've seen any pictures of Bryan Adams lately. Let's just say he has changed from his youth. How did an '80s icon turn from "Mr. Rebel" to "Mr. Skinny Soy Latte?" But, I digress. Here's some trivia about the song:
The song peaked at #5 on the U.S. Billboard charts in 1985, but hit #1 in Canada (the birthplace for Adams). The single went platinum in the U.S. and quadruple platinum in the U.K., selling more than 5 million copies worldwide. The song was the second release from the "Reckless" album, an album that went 5x platinum in the U.S. alone! For those of you who grew up in the streaming age, that's a lot of records.
Adams wrote this song with Jim Vallance, who collaborated with Adams on a number of his hits. Vallance also wrote several Aerosmith hits. Since this song was written about 1969, when Bryan Adams was 9 years old, the song is really more about looking back than about the actual year 1969. Adams stated, "For me, the '69 was a metaphor..."
Vallance has admitted that several lines in the song were inspired with other songs. The line "I got my first real six string" was inspired by "Juke Box Hero" and the line, "I bought a beat up six-string in a second-hand store." The line, "Standin' on your mama's porch, you told me that you'd wait forever" was sparked by Bruce Springteen's "Thunder Road" and the line, "The screen door slams, Mary's dress waves. Like a vision she dances across the porch as the radio plays." Finally, the line "When you held my hand, I knew that it was now or never" was influenced by The Beatles "I Want To Hold Your Hand."
"I got my first real six-string
Bought it at the five-and-dime
Played it 'til my fingers bled
Was the summer of '69
Me and some guys from school
Had a band and we tried real hard
Jimmy quit, Jody got married
I should've known we'd never get far
Oh, when I look back now
The summer seemed to last forever
And if I had the choice
Yeah, I'd always wanna be there
Those were the best days of my life"
Here's what we've seen so far this week...
Summer of '69. I don't know if the "summer seemed to last forever" in 1969, but the Federal Reserve did hike rates multiple times that summer to equal 6 total hikes in that year. The rate on the 10-year Treasury went from 6% to 7.45% in that year. The situation today is quite different.
In fact, growth was stagnant in 1969, with GDP averaging around 1%. GDP for the 3rd quarter was released this week and it showed growth of +4.9%, which was higher than expected and more than double the rate of growth compared to the 2nd quarter. The move higher was due largely to a rebound in consumer spending. This puts the U.S. on pace for potentially 3% annualized GDP. Certainly a contrast to 1969. The Fed Funds Rate by the end of the hiking cycle was over 9% in 1969. A bit of Trivia, the Fed did not begin announcing their rate decisions following FOMC meetings until 1971. While the most recent Fed hiking cycle has been unnerving, it's nothing compared to the amount of slowing that occurred in 1969. Inflation was also much higher in '69, running at 5.9% year-over- year compared to 3.7% currently. Lastly, the yield on the 10-year Treasury was 7.51% by the end of 1969, while it's only 4.95% as of Wednesday.
While the Fed rate hiking cycle almost immediately led to a recession in December of 1969, the current Fed rate hiking cycle stands in contrast as it was due largely to the build up of excess money and artificially-generated inflation having flooded the system during COVID. While we don't have the luxury of looking at the Fed indices that track economic conditions in 1969, we can see what things look like today. The National Financial Conditions Index tracked by the Chicago Fed was not in existence in 1969.
However, that Index currently reads -0.35, which indicates loose financial conditions. In August of 2007, just before the 2008 Financial Crisis, the index had a reading of +0.28, which indicates tight conditions. One of the contributors to the index is "Risk" which has dramatically declined to -0.24 versus a nearly flat reading of -0.04 during the Banking Crisis earlier this year. Also in stark contrast is the St. Louis Fed's Financial Stress Index - also not available in 1969. That index currently reads -0.49, which indicates little financial stress in the system. Similarly, in August of 2007, the index was much higher with a reading of +1.21. Of course, conditions will change, but as we sit here today, the prognostications of gloom-and-doom just haven't materialized.
Those Were The Best Days. I remember the go-go years of the late '90s when markets seemed to go up almost every day.
That hasn't been the case this year. after suffering a mild bear market last year, equities have been flat this year. In fact, since July 31st, the divergence between equities and fixed income yields is quite obvious. Since July 31st, the yield on the 10-year Treasury has increased 98 basis points, while the S&P 500 Index is down 8.7%.
Equities have seen 34 trading days since the 31st of July where values declined. In 55% of those trading days, the interest rate on the 10-year Treasury moved higher. This tells us that the correlation between rising rates and lower equities is rather strong right now. There is a case to be made for interest rates to be at or near peak and for future Fed rate hikes to have concluded. Stanford economist John Taylor posited a rule in 1993 that states a central bank's policy rate is tied directly to inflation and economic growth.
According to the rule, the spread between Fed Funds and the baseline Taylor Rule calculation is the lowest since 2021. This would indicate the Fed is done raising rates. The current Fed Funds futures show a 99.4% probability of no rate hike when the Fed meets next week for their November FOMC meeting. The probabilities for no rate hike in December have reached their highest point of 79.8%. As the market begins to accept the fact that interest rates have peaked, look for equities to get a little wind at their backs for the remainder of 2023.
For those of you who grew up in the era of MTV, here's the video....
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