In case that wasn’t clear … nooooo!!! I like to follow Bloomberg, CNBC and other business news sources. Not because they offer much in the way of market insight, but to see what the “mainstream” narrative is. Twenty-something experts are not always wrong, but when they are, it usually means opportunity. That has been the case for a few months. Let me try to frame the mainstream story:
Inflation has risen sharply because of Covid, Ukraine, and consequent “supply chain disruptions” etcetera. The US Fed and other central banks are diligently fighting this exogenously caused inflation by raising interest rates and shrinking their balance sheets. This has caused stock prices to fall. But as inflation readings have gradually fallen over the last few months, this brings us closer to the time when the Fed can stop raising rates, lifting the lid on stock prices, and unleashing a new bull market.
I really like this narrative. It’s just sooo wrong. On multiple fronts. When the crowd is really wrong, it creates powerful outperformance opportunities.
Just one of those fronts is the assumption that there’s a lid keeping US stocks down. Free of outside influences, they would be much higher. Nothing could be further from the truth. US stocks have been levitated for years by unusual, unnaturally low interest rate policy and money printing. That support is gone. So left to their own devices, free of outside influences, they would fall.
Another is the fantasy that consumer price inflation is an anomalous aberration that can promptly normalize without asset prices coming down. Financology has discussed this ad nauseum so it need not be belabored here. All prices – asset and consumer – are subject to the same inflation, just not at the same time. Asset prices first, consumer prices later. There is no planet on which stocks can rise by double digit percentages in perpetuity without consumer prices eventually following suit. We’ve reached the end of that road for this cycle. So there is likewise no planet on which consumer price inflation will come under control while stocks shoot higher.
The Fed will stop hiking, and probably start cutting, before too much longer. But only if stock prices go lower first. That will finally break consumer price inflation. The Fed has glommed onto this asset price relationship, so it’s not just abstract Financology theory. But the Fed itself hasn’t got it all right either, because it appears to think it has lots of time to finish its hiking mission. The bond market begs to differ. I’ll have to go along with the bond market on this one.
The third shaky leg of this rickety stool is that once the Fed begins to cut rates, stocks will soar. Eager dip buyers should recall, however, that the Fed cut rates all the way though the last two major bear markets. In the 2008 debacle, for example, the first rate cut came before the bear market even started. That happened in September 2007 … stocks peaked in October.
The opportunity that appears to present itself now is that the stock market is still in the early phases of correcting its misunderstanding. As it does, prices decline. But it still hasn’t given up on the flawed narrative we outlined earlier; it still has a ways to go. This of course doesn’t mean there won’t be bear market rallies – every bear market has them – but unless you’re a nimble trader, they’re a high risk game. Realistically, someone who is far below their target equity allocation could add a bit on dips like these, but this is not the time to be backing up the truck. For most of us, the opportunity is to resist the impulse to BTFD.