Jeff Sommer Sept. 22, 2023 The New York Times
The stock market has basically gone nowhere since the start of last year. That’s no great claim until you remember how battered most stocks were last autumn.
From its peak on Jan. 3, 2022, to its trough on Oct. 11, 2022, the S&P 500 lost more than 25 percent of its value. The stock market has mostly recovered. Under the circumstances, that’s an achievement.
Stocks, after all, have run afoul of one of the oldest adages on Wall Street: Don’t fight the Fed. When the Fed is tightening monetary policy — mainly by raising interest rates — it is difficult for the stock market to prosper. This is a lesson from Wall Street history, and, in the second year of a Fed tightening cycle aimed at taming inflation, it remains relevant.
Fed policymakers meet again next week to set interest rates. A government report on Wednesday showed that inflation remained uncomfortably high, with a 3.7 percent increase in the Consumer Price Index in August. Though inflation hasn’t dropped to the Fed’s 2 percent inflation target, the overwhelming consensus in the futures markets is that the Fed won’t raise interest rates further in September.
But the short-term interest rates the Fed controls directly have already risen sharply since early 2022 — from near zero to a range of 5.25 to 5.5 percent now. And while a rate increase may be unlikely this month, for short-term traders, the big questions remain: Is the Fed done, and when will interest rates finally decline?
I think they are more likely to rise than fall over the next several months, and I see no reason to argue with the projections in futures markets or those made by the more than 50 economists polled by Blue Chip Economic Indicators, a monthly survey published by Wolters Kluwer: A drop in interest rates isn’t likely until next year, and probably not until midyear, at that.
Then again, I have no confidence in my own ability to forecast the timing of major changes in the economy and the markets — and I doubt that anyone else has the ability to do so consistently. Certainly, professional economists and Wall Street forecasters have tried and failed for decades. Making predictions in this economy has its own special pitfalls.
For one thing, the interest rate environment is unusual.
Short-term rates — specifically, for 3-month Treasuries — are higher than those of longer duration — particularly, for 10-year Treasuries. In financial jargon, this is a classic “inverted yield curve,” and it often predicts a recession at some point in the future.
Right now, though, the markets have been waiting a long time for that prediction to be borne out — so long that they have set a dubious record. In fact, the yield curve has been inverted consistently since Nov. 8, 2022. On Tuesday, that amounted to 210 trading days, surpassing a 209-day streak that ended in May 2007, roughly six months before the great recession that began in late 2007. Bespoke Investment Group reported the streak to clients, using data going back to 1962.
This stretch of uncertainty about the possibility of a recession doesn’t just feel like it’s been going on for a long while. It really has.
If you’re not entirely familiar with yield curve inversions — and who could blame you? — here’s a quick primer.
Inversions happen because the Fed sets the shortest rates, while traders set longer rates in the vast bond market.
Now, consider that most of the time, when you borrow money, you pay a premium for a longer loan. That’s true for bonds as well as for mortgages and car loans.
So when short-term rates are higher than those of longer term — when the yield curve is inverted — the markets are saying that something is amiss. What it could mean is that a recession is in the offing, because the Fed tends to reduce short-term rates when the economy is weakening.
It is, of course, possible that this time around, the economy won’t falter under the burden of higher interest rates, and the Fed rate cut will simply come when the central bank judges inflation to be under control. There may be a “soft landing,” as the Federal Reserve chair, Jerome H. Powell, has said.
I hope so. But I’m not counting on it.
The unemployment rate remains low — despite a recent uptick — and the economy, as measured by gross domestic product, has been growing nicely. But another important indicator has been signaling trouble for months.
That is gross domestic income, or G.D.I., a close cousin to G.D.P.
Over the last year, G.D.I. has shown the economy to be shrinking, not growing as the G.D.P. numbers have indicated. The gap between the two measures has been wide and baffling.
A decade ago, the contours of the economy were also being obscured by a bewildering data fog. As I wrote then, G.D.I. and G.D.P. should, in theory, be equal. One measures gross income, the other gross production. They ought to match, but in real time, they frequently don’t, because they use different sources, deadlines and definitions.
G.D.P., for example, depends heavily on sales receipts, while G.D.I. tracks paychecks, which are often issued well after sales are made, as J. Steven Landefeld, then the director of the federal Bureau of Economic Analysis, told me in 2013.
Which measurement is more reliable now? I’m beginning to tilt toward the cheerful message coming from G.D.P., with a caveat: The heavy hand of the Federal Reserve is distorting the picture.
The Bureau of Economic Analysis will be making major revisions of G.D.P., G.D.I. and other measures at the end of the month. Preliminary notes on the changes are available, and they are likely to substantially increase the numbers in G.D.I. going back many years.
Among other shifts, G.D.I. is being reworked to include net interest payments made by the Federal Reserve to banks and money market funds. Precisely because the Fed has raised short-term interest rates since early 2022, it is now paying more than 5 percent in interest annually on more than $4 trillion in bank reserves and “reverse repo” — essentially, money market fund deposits. These interest payments are big money, so big that Michael Feroli, the chief economist at J.P. Morgan, estimates that including them in G.D.I. will eliminate half the G.D.P.-G.D.I. gap. (Other revisions may reduce the gap further.)
So G.D.I. is likely to look a lot better very soon. But the upward shift isn’t entirely comforting. It’s yet another reminder of the gargantuan role of the Federal Reserve.
Long-term investors with strong stomachs can simply ride out the monetary cycle and needn’t obsess about what the Fed will do next week or next month.
Instead, more personal questions dominate. Are you well positioned in your investments and cash holdings, both for the short term and the long haul? Thanks to higher interest rates, bonds are an increasingly appealing alternative to stocks, and if you need a place to stash cash, yields on money market funds are above 5 percent, a splendid return.
The stock market has produced better returns than bonds and money markets over the last century, and I assume that it will continue to do so. So I think it makes sense to hold low-cost diversified index funds giving you a share of global, publicly traded stock markets as core investments.
The U.S. stock market could well rise sharply again, as it did this spring and summer, but I suspect that until the central interest rate question is settled, a consistent path upward will be hard to find. But I’m hanging in anyway. And there are plenty of good short-term options.
c.2023 The New York Times Company
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Posted: to Wealth Management News on Thu, Sep 28, 2023
Updated: Thu, Sep 28, 2023