August 12, 2021
Have you had the chance to go on the virtual reality ride at Epcot Center called Soarin’?
It’s nothing short of incredible. You seemingly “soar” across oceans… feeling the sea mist spray your face as seagulls sing in the distance. You tour the wonders of the world, even flying high above the pyramids of Egypt. It’s as though you’re really there…
The ride is in many ways an astonishing glimpse into our future… Virtual reality, or VR, will have the power to influence us and our experiences in amazing (perhaps even terrifying) ways.
Meanwhile, back here in the real world, the Fed is playing with its own kind of alternate reality. This team of Federal Reserve bankers has managed to create a VR experience to rival Disney’s all on its own… designed to convince investors they too can keep on soarin’.
And soar we have… The markets are at all-time highs with all indications suggesting they could move even higher still.
The End of Rationality
But here’s the reality… Despite having experienced the shortest (albeit deepest) recession in modern times from February through April of 2020, we’re printing massive amounts of money as though we’re still in the midst of a recession.
Combined with fiscal stimulus from lawmakers, we’ve landed ourselves in the middle of a huge liquidity infusion, the likes of which we’ve never quite seen. In fact, an estimated 22% of all U.S. dollars in circulation were printed in 2020 (wow!)… And 2021 shows no signs of slowing down the printing presses.
Making matters worse, the money printing comes after more than a decade of record-low interest rates… And the current rounds of stimulus, including $120 billion per month in bond buying, are designed to help keep those interest rates low. After all, if the Fed creates this demand buying up bonds itself, interest rates will stay low – hence the 1.3% yield on the 10-year bond.
It’s no wonder why we’re now seeing inflation… and mass appeal in risky cryptos and meme stocks.
It’s as though folks feel like they have money to burn. Investors are so far out on the risk curve that they’re throwing almost all caution to the wind. There’s no rationality when it comes to investing these days. All this financial engineering has effectively created an artificial market – or a virtual reality – for investors.
After all, why be rational? Why ask the tough questions surrounding actual valuations of companies? It seems the rational folks are the ones punished the most in this crazy environment. It doesn’t pay to be logical when the Federal Reserve has turned the markets into a kind of Disney World playland.
The question now is… when does the ride stop? And can the economy and markets survive without the help of the Fed’s stimulus?
These are the issues the Fed and investors must grapple with two weeks from now at the Fed’s annual shindig in Jackson Hole, Wyoming.
The Cannes Film Festival for Wonks
Since 1982, the Federal Reserve Bank of Kansas City’s Economic Policy Symposium in Jackson Hole, Wyoming has been the go-to event for economic professionals, investors, academics, government representatives, and members of the media. Think of it as the elite Cannes Film Festival… for wonks.
From August 26 to 28, amid the stunning peaks of the Grand Tetons, the Fed’s governors will communicate their message subtly (and not) to the event’s participants. The subsequent headlines will make their way into the papers, and before you know it, the markets will adjust and possibly a new trajectory will be set.
Already, there are messages that are beginning to leak in the lead-up to the meeting. And if the previews are any indication, it seems this insane world of the Fed’s virtual reality is scheduled to continue…
At present, there’s talk of moving current Fed Chairman Jerome Powell aside in order to make way for someone far more dovish and in favor with Treasury Secretary Janet Yellen, former head of the Federal Reserve.
Lael Brainard, a former professor at MIT who served as the under secretary of the Treasury for International Affairs at the Department of the Treasury, joined the Federal Reserve board in 2014. Brainard has an impressive background, is well-liked, and was mentioned repeatedly as a possible contender for secretary of the Treasury under President Joe Biden, though he ultimately went with Yellen. (Brainard had also been discussed as a contender for the position had Hillary Clinton won in 2016.)
In appointing Brainard to head of the Fed when Powell’s term expires, Yellen would help ensure a more dovish and more politically aligned view of the economy, particularly with that of the current administration.
Are Powell’s Days Numbered?
Though Powell seems to be doing everything right in the eyes of the administration, he isn’t quite “their” Fed chief.
He was, after all, appointed by the man the Left despises so adamantly – Donald Trump. In fact, Powell took Yellen’s spot – unseating her as Fed chief when her term was up.
(I always thought that Trump, knowing how keen he was to print money and issue debt, would have been better off keeping Yellen in the seat. Nonetheless, he wanted his own guy, as did then-Treasury Secretary Steven Mnuchin.)
So, it makes logical sense that Yellen and Biden would seek a change.
The worst thing you can do is to sit idly by and do nothing. Find out exactly what’s going on in America, why this grocery store billionaire is so concerned about this coming October, and four steps every American should take right now, right here.
It’s a strange world we live in when bad is good and good is bad… But when balancing the risks and rewards of investing amid a Fed-induced sugar high, the world seems upside down.
After all, to continue sending stocks higher despite the continued threat of COVID shutdowns and a new variant making its way through the economy feels pretty insane. Cooler heads are warning against a new kind of “irrational exuberance” (a term well-coined by noted Fed Chair Alan Greenspan when describing the insanity of the dot-com bubble).
At times, that 2000 bubble feels almost quaint in comparison with what we’re seeing now… When tweets and Reddit forums can send investors rushing into stocks or little-known cryptos, we have reached what I’d call a new kind of irrational exuberance. Howard Marks, the co-founder and co-chair of Oaktree Capital, just warned investors that markets are in an “everything bubble.”
Now, the economy is improving… even if it’s not as strongly as we’d all like. The jobs picture is showing some signs of strength, with 943,000 jobs being added to the economy in the month of July and unemployment falling to 5.4%.
Yet, the labor-participation rate remains weak, and there are still more than 10 million jobs currently available. Translation? People don’t want to work. I mean, why should they when Uncle Joe is still handing out unemployment benefits?
Those benefits are scheduled to end this coming month, but just like we saw with the eviction moratorium, there will be political pressure to renew them amid the hysteria of the Delta variant. Even schools are talking about shutting down again… So how will parents go to work without their kids in school? The Left will argue (again) that the benefits are a necessity, and sure enough, this whole cycle will repeat, with the Fed continuing its liquidity push.
Now, there are some sensible people on the Fed’s Board of Governors… I’ve known Fed Vice Chair Richard Clarida for many years, including when he was at investment management company PIMCO and at Columbia University, and have always been impressed by his logic on the economy. Rich is encouraging a pullback in the Fed’s tapering (the gradual slowing of the pace of the Federal Reserve’s large-scale asset purchases). And there are others who support this too, including St. Louis Fed President James Bullard and San Francisco Fed President Mary Daly.
Heck, I wouldn’t be surprised if Powell himself comes out in favor of unwinding the bond asset purchases…
But when that happens, you can expect a taper tantrum from Wall Street… and you can count on one from the White House, too.
Keep in mind, the administration knows how this all works… They’ve got the former head of our central bank as Treasury secretary! They want lower rates and additional liquidity in the system, which explains the significant pressure on the Fed to keep the spigot open – even in the face of a declining unemployment rate… and even in the face of significant inflation.
If Powell is unwilling to comply, Brainard is waiting in the wings… and already has the stamp of approval from liberal elites.
So what does it all mean?
Despite the current craziness of these markets, my sense is that the Fed will continue keeping the status quo. Even if it does begin to taper in the fall, if history is any guide, it will still take a couple of years before the Fed ever gets around to raising rates.
Consider this: In 2013, the Fed began winding down its quantitative easing nearly five years after the 2008 financial crisis… yet the first interest-rate hike didn’t occur until December 2015.
This tells me that we still have plenty of time. Now, of course, we risk the creation of a massive asset bubble worse than anything we saw in the year 2000. And let me be clear, I’ll take a sell-off in the stock market any day over a systemic credit crisis.
If the Fed’s financial engineering hasn’t modeled out what happens when inflation keeps accelerating, and there’s not enough overall economic growth to support the influx of cash into the economy, the consequences will be hazardous.
At that point, we risk the “hard landing” or crash that some bears keep warning of. But we can manage a pullback or a bear market. The macro danger is that all these years have led to riskier behavior and reduced loan quality… and if the economy stumbles again, the entire system gets sucked into a downward spiral.
Now, I’m not in any way suggesting this will happen – that’s a worst-case scenario. Let’s all hope our Federal Reserve is sophisticated and nimble enough to prevent something this catastrophic.
As investors, we must always be prepared… and stay grounded and vigilant. Continue watching the yield on the 10-year U.S. Treasury (which is still amazingly low) for any signs that it’s ticking higher.
And have some conviction. Don’t buy stocks just because everyone on Reddit or Twitter is talking about them… Instead, do your homework and due diligence to understand a company’s business model. It sounds almost quaint and old-fashioned in this day and age, but truly the smart, steady investors tend to win the race… and get to sleep better at night along the way.
It’s time to take the Disney VR goggles off and face the real world.
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Publisher, American Consequences
With Editorial Staff
August 12, 2021