It would seem some people have forgotten that the Federal Reserve is still raising rates. They have given no indication that they are stopping anytime soon. And the full effects of earlier rate hikes have yet to be seen. We were given a glimpse with recent earnings reports from the major tech companies, all coming up short.
You may want to say that Apple did just fine, and the tape would appear to support that thesis. But does Apple deserve a 25 PE and a one-day gain of 8% when their annual revenues and earnings were up 8%? Really? Please think twice before jumping on this bandwagon and instead, trim any long positions, particularly in tech.
Liquidity in Decline
… that just means people and businesses have less money to play with. In addition to raising short term rates at the most dramatic incline in decades, the Fed is also aggressively paring its holdings, removing an important catalyst for lower rates across the board.
When the pandemic started and markets crashed, the government did three things that created an environment ripe for asset bubbles:
- Congress started giving out money to everyone – PPP Loans, outright payments to individuals, etc.
- The Fed reduced rates almost immediately to 0%
- The Fed started buying government bonds and mortgage-backed securities hand over fist
Other governments around the world acted in similar fashion. Together, these efforts introduced a flood of money into the economy and that money needed a place to go. Just a few of the assets that appreciated immensely from March of 2020 until the end of 2022:
- Stocks – The Nasdaq 100 (NDX) is still up ~20% from its previous peak and 65% above the pandemic low (at the peak, it was up 72% from the previous peak)
- Bitcoin and other similar “assets” – from ~8,000 in March 2020, still over 20,000 (150%)
- NFTs – I just can’t say enough bad things about this even more non-sensical “asset class”
- Comic Books – Amazing Fantasy 15 (1st Appearance of Spider-Man), and similar key issues, catapulted in value nearly 300% since March 2020.
- Gold – roughly flat from the pre-pandemic #s, which is curious as Gold typically is an inflation hedge.
- And, of course, other commodities, food, oil, everyday goods, i.e. Inflation
Exacerbating the problem was the pandemic, of course. Fewer people were working to create things. Supply chains were disrupted. There were fewer products available to spend the windfall. This inflation was predictable in hindsight. When there is too much money chasing the same or fewer goods, assets are bid up.
All Engines in Reverse
In addition to raising rates, the Fed has finally started reducing its balance sheet, to the tune of ~$60 billion a month starting this past September. No one can definitively quantify what this is doing to the economy; however, at a minimum, we have lost a huge buyer of Treasury and Mortgage-Backed Securities. No one is left to prop up this enormous market.
Some say foreign buyers will step back up to the plate as rates rise and, sure, they will. But that doesn’t mean we don’t have further to go.
The full impact of rate hikes and balance sheet reduction have not yet hit. What happens when they do and the overall economic numbers start to reflect the changes. I believe it is called recession. The worst is yet to come.