Don’t Fight the Fed: Daily Contrarian, June 13
Stocks are pointing to a dramatic sell-off at the open as investors grapple with the reality of stubborn inflation and higher interest rates…
Good morning contrarians!
This briefing was made free after being sent to (paid) premium subscribers on the morning of Monday, June 13, 2022
There is nothing in terms of economic data releases on the calendar today. The only earnings worth mentioning is Oracle (ORCL) after the close at 1600.
This week will be all about the Federal Reserve, which starts its two day policy meeting tomorrow. The FOMC will announce interest rate policy on Wednesday afternoon. There is some debate on whether the Fed raises by 0.5% or 0.75%. We’ll deal with this in more detail tomorrow and Wednesday, but the important thing is that the Fed is hiking interest rates, and aggressively.
That simply doesn’t bode well for the economy. Recent comments from Stanley Druckenmiller at the Ira Sohn Conference have attracted some attention on this topic. One Jon Bond (perhaps a pseudonym) has a summary of Druckenmiller’s comments on CommonStock if you don’t want to watch the full video.
The main gist of Druck’s comments as it relates to the Fed is as follows:
Once inflation gets above 5%, it’s never come down without the Fed funds rate above the CPI. The CPI is currently 8.6%. Fed funds was 0.83% as of June 9 and priced to peak at 3.3% next year.
Once inflation is above 5%, it’s never been tamed without a recession.
This speaks to the futility of hoping for a ‘soft landing.’ It’s hard to see how the Fed raises rates like this without causing demand destruction. In fact, that’s very much the Fed’s stated aim as it is a necessary course to rein in (non-transitory) inflation.
This doesn’t mean there aren’t signs to hope for a rebound in certain risk assets. For one, bonds and stocks simply can’t keep selling off together for very long without the proceeds being put to work somewhere. With inflation now not yet past its peak (per Friday’s CPI reading) and the Fed set on reining it in, this makes bonds a very bad place.
And stocks? Probably not growth stocks or anything based on the promise of better days. Despite having been beat up these last six months, it’s hard to see how they turn around anytime soon in this type of environment. Perhaps consumer staples that can successfully pass their costs on to consumers. We’ve had podcast guests make this argument. Druckenmiller said as much as well (he also says he likes gold in this environment).
The Bottom Line©
Don’t fight the Fed. To repeat: Do. Not. Fight. The. Fed.
Once the Fed sets a course for higher interest rates, it is only a matter of time before this cuts into economic growth. Higher interest rates raise the cost of borrowing money, which make it more expensive for companies to finance expansion, which cuts back on hiring, which creates unemployment, which crimps consumer spending, and the whole thing takes on a vicious cycle of its own.
It’s not a question of if, only when this happen. The whole thing is precipitated by high inflation (going on back to Druckenmiller’s comments above). The Fed has no choice but to tighten monetary policy given the rate of inflation. And inflation, as we saw on Friday, has not yet peaked.
As this reality dawns on markets we can expect to see more selling, especially of riskier assets. Just look at cryptos, with bitcoin down to levels not seen since late 2020. But probably of everything. That may eventually create buying opportunities in certain sectors. Maybe. Eventually. Of course nobody knows where the bottom could materialize. Do your own research, make your own decisions.