The economy and the stock market are stuck in a circular loop, preventing meaningful growth from resuming. The US Federal Reserve has been doing what it can to try to undo the stock market since late 2021, aiming to cut Wealth spending pressure on inflationary imbalances. For several months, the Federal Reserve has been hinting at the necessary pretext for shifting interest rate policy from high (tightening credit) to a bearish regime (expanding liquidity), that is, a larger decline in stocks on Wall Street. The problem is that the Fed’s attempts to talk rate cuts and valuations are getting very little attention.
In addition, actual increases in bank interest rates have not been able to flood the economy enough to reverse policy to a neutral or accommodative stance. The conundrum facing the Fed governors is that inflation will not return to 2% or more Annual targets of 3% on their own, while Treasury deficit spending and interest expenses are rising due to credit tightening efforts.
A technical bear market drop of -20% is sure to become a reality in 2022 for major indices. But, with general inflation and “core” cost-of-living numbers still in the annual range of 5% to 6%, banking policy is completely cornered by more price increases until something breaks. I have indicated the potential for a fracture of the financial system several times since the summer, as it is now a prerequisite for ending this tightening cycle. For example, (1) the dollar could decline in foreign exchange markets as confidence about US deficit spending trends reverses, (2) banks may refuse to originate new loans as creditworthiness deteriorates and affordability issues arise when prices rise, or (iii) The stock market may crash due to corporate earnings issues in a growing recession.
My cautious view hasn’t really changed in January, which means the latest rally in Standard & Poor’s 500 (SPX) (SP500) (SPY) (VOO), Nasdaq 100 (NDX) (QQQ) f Dow Industries (DJI) (DIA) has done nothing to change the status quo.
Borrowing, debt, and Treasury rates today are frankly too high to sustain the economy, but too low to slow inflation to 2% year-over-year from the Fed’s targets. In the absence of something breaking to add weight to the negative macroeconomic pressure, while encouraging more conservative consumer/business decisions, interest rates may not change significantly in 2023. So, if corporate earnings start to decline and interest rates don’t, where is the power Sustainable purchasing of the stock market come from?
The problem of treasury debt is getting bigger
There is no doubt that escalating interest expenses on $31.4 trillion in sovereign debt could crush all hopes of a prolonged economic recovery after 2023. From a total expense decline of nearly $400 billion during fiscal 2015, the number of interest payments for 2022 nearly doubled to $724 billion. dollars (on insane pandemic borrowing and high interest rates now on massive refinancing activity annually), and it’s set to top $1 trillion once fiscal 2023 ends in October!
With the deficit rising (again as the economy slows) and today’s rate of 4.6% is set at the short end of the duration curve (where most of our deficit financing and refinancing needs are located), the Treasury supply could soon crowd out capital flows into production. parts of the US economy, especially when the Fed tightens quantitative easing (selling Treasuries). A trillion dollars in interest expense works out to better than $3,000 for an individual in America, or $12,000 for a family of four as your share each year, just to pay interest on decades of previous borrowing. If interest rates do not come down soon, escalating interest costs for Uncle Sam, businesses, and consumers could make future economic expansion impossible. My estimates are that each 1% increase in the entire yield curve adds about $100 billion in annual expenses over 12-18 months and up to $200 billion annually over 10 years, with an average maturity of just over 6 years (assuming deficit Annual financing needs of $2 trillion annually in the future are being funded at much higher rates than in 2021).
Newly elected House Republicans believe they can magically cut spending to balance the budget, but this will likely only lead to a recession this year or next, as government spending support for the US economy (emergency deficit spending since then) is eliminated. Then) the Great Recession of 2008 that was funded by the Federal Treasury’s purchase of quantitative easing). I suggest we don’t experiment with this drug, because hyperinflation or economic deflation would not be pleasant or constructive for any subset of the population (perhaps a select group of properly groomed individuals).
The odds of recession are increasing daily
So if the stock market continues to go higher, which is what encourages the Fed to continue to tighten, where is this all leading? My simple answer is – problem. While many market followers believe that a stock market rally in early 2023 means a recession won’t happen, I have news for you. We’re in a tight noose, with the good news inevitably making Wall Street swoon and a US recession more likely in the long run, not less. And the stronger the economic news in early 2023, the more the screws will tighten on the interest rate, prompting a legitimate credit crunch to overextend it.
The prevalence of a record 40-year inversion in the Treasury yield curve has become quite evident since November. In fact, the spread of higher rates on the short end versus now declining returns over the long term is a serious warning against the 3-month or 6-month. She loudly predicts a vicious slowdown in the economy sooner rather than later. Thus, I will follow the facts with my investments and not chase volatile crowd sentiment this week or next.
what should be done?
I’m sitting at only 10% invested in common stocks today, because an economic slowdown toward a recession may be certain, in my opinion, having followed and traded the markets since 1986. I’m about 35% invested in 4% cash dividends, plus another 30% in cash. Medium- and long-term bond funds that earn 5% as a 3-6 month trade (assuming a recession is next, and the Fed can prevent a treasury crisis of confidence). Lastly and most importantly, I invested about 25% in gold/silver/platinum bullion and the two cash-related metals. A shockingly bad economy later in the year could cause a flood of buying interest as investors, institutions and governments rush to the purest form of financial safety. If we only have a mild recession, with another 15% to 20% of stock market downside, that mix of assets should continue just fine. I would estimate that the portfolio’s net asset allocation should grow a little bit in value, maybe +10% to +15% for annualized rates.
The point is, I’m pretty much stepping back from the market for a while (not short stocks care about you), waiting for a smarter entry setup. I’m still doing the usual research and writing about stocks I can find with momentum characteristics and misunderstood stock valuations – really worthwhile ideas in a risky market environment.
In addition, I’m willing to give up choppy 5% or 10% hikes, as we’ve seen through July, August, November and January, patiently waiting for something to break. My point is that a significant upside on Wall Street is somewhat unlikely, as the stock market remains overvalued (a function of total value still near all-time highs versus GDP, excluding the 2020-2021 bubble) and remains Interest rates are in the 4% to 5% range (a 15-year high for most periods). The Fed has no tenable excuse to cut interest rates with inflation running above 6%, and negative “real” (adjusted for inflation) returns are still here and now.
The fully invested portfolio is now in a position to “fight the Fed,” which has proven to be a difficult task throughout history. The Fed would prefer a recession and a lower stock market so that it can cut interest rates quickly putting pressure on Treasury debt expenditures. This is the end game in all of this – keeping the Treasury solvent and able to function.
Otherwise, we will witness a real crisis of confidence in the dollar and a recession much worse than any of us have experienced. Record sovereign debt to GDP of nearly 140% has grown to catastrophic proportions, as another deep recession could drive our economy into submission from which it cannot easily recover. Modeling a severe recession with $3 trillion in new federal deficits annually on a shrinking or flat GDP number (depending on inflation rates) could convince foreign investors that America’s fiscal prowess is about to come to an end. Capital outflows to fund our continuing deficit spending are no guarantee of a way forward. Do not fool yourself. America is no exception. In the end, the corrupt federal deficit/debt math will catch up with us. Succeeding in living dangerously for decades could end in a financial downturn, perhaps suddenly when a new black swan event appears.
Please refrain from calling me a bear, bull or pig for now in the direction of the market. Take me back like a chicken. My goal is to live to fight another day. This tiger will pounce out of its chicken costume when the time is right, perhaps when the stock market is forced to discount sagging corporate earnings in a recession and the Federal Reserve can get back to printing money again.
Thanks for reading. Please consider this article as the first step in the due diligence process. It is recommended to consult with a registered and experienced investment advisor before undertaking any trading.