What Happens Next
Dear subscriber,
The Federal Reserve came out with a 50-basis-point rate cut on Wednesday. That's larger than most economists (and yours truly) expected.
It's also the first time since 2005 that a Fed governor lodged an official dissenting vote. Fed Governor Michelle Bowman preferred a quarter-point cut.
Many speculate that the central bank feels it should have cut the interest rates in July... but that it got disappointing news on the jobs market just a little too late.
So this week's 50-basis-point cut makes up for that. It includes the 25-basis-point cut we should have received in July, plus the 25-basis-point cut for September.
The truth is that the size of the cut doesn't matter much...
What matters is that we're in another rate-cutting cycle.
Unless the Fed botches things for the economy, rates won't go down at one meeting and up the next. The Fed has put us on a path for rates to head lower over the next year or two.
That means we're at a key inflection point in the market... one that only comes along every five years or so.
Our colleague, Dr. David "Doc" Eifrig, addressed this in a recent issue of his Retirement Millionaire advisory.
It's the most important thing you need to understand right now. So this week, we're running an adapted version of his essay to prepare you for the year ahead...
The Final Lesson in Your Investment Education
The future of the market is in your hands.
And you'll see that once you complete your investment education today.
No, I'm not retiring (again). I'm going to keep working on Retirement Millionaire for years to come. And we'll always have new information to share with you.
But everyone who learns about the market follows a path... It's not always the exact same, but it's often similar.
You learn about stocks and bonds. You learn enough accounting to figure out how the intrinsic value of a business can grow. And you learn how expectations assign a valuation to that number.
You figure out what sectors reward shareholders, and through which parts of the economic cycle.
And you eventually learn that patience and caution build wealth over time.
You read about Warren Buffett and Peter Lynch and collect all the ideas you need.
But there's one lesson that's fairly far down the list... though it's an important one.
Many investors never get to it... but they should.
And it's a lesson that's important right now.
That's because we've got strong, competing forces in the market today.
I won't sugarcoat it... Economic growth is slowing down. The go-go economic boom fueled by pandemic-stimulus spending and happy consumers is ending.
On the other hand, the Fed knows this and is ready to goose monetary policy to attempt to avert disaster.
Slowing economy, lower rates... The key question for investors is what this means for stocks.
The answer: We don't know right now. We can't know.
But we are at an inflection point... And we're going to share the secret of how to think about what's next.
Today, we'll explain the investment philosophy that should guide your thought process as you navigate these uncertain market conditions.
Let's start with a lesson I learned in a 1987 book by a brilliant but controversial investor...
Today's Lesson: Reflexivity
George Soros got famous for making $1 billion in a day, shorting such a volume of the British pound that the Bank of England could no longer support it.
While some folks associate Soros mostly with his left-leaning political donations, he's considered one of the greatest investors of all time. His Quantum Fund delivered 30% average annual returns for nearly three decades.
Also, Soros doesn't fit a particular mold as an investor. He focused on big macroeconomic opportunities and applied a trader's intuition as he sloshed around billions of dollars.
By the time he tried to lay out his philosophy in his 1987 book, The Alchemy of Finance, he had found the essence of what drove markets...
Thinking participants.
While economics wants to be a science, predicting the behaviors of rational people to divine the future, it simply can't be.
Soros points out that markets are social creatures. And that changes how you need to look at them.
Try as you might to understand investing from an economics, finance, or accounting textbook, you'll never quite crack the code. Soros' trick was to loop in psychology.
Soros has two key principles regarding markets... fallibility and reflexivity.
The principle of fallibility: Whenever thinking participants are involved, they never fully understand the real world. No one, no matter how hard they try, can capture all the data and look at it without being biased or inconsistent.
The principle of reflexivity: This same fallibility influences the way people behave in markets – which affects the markets themselves.
That is, what is done by thinking participants changes what happens next. People react to predictions and expectations, and therefore negate the previous forecast.
Soros has a great two-statement example of this.
Consider the statement, "It is raining." That is a statement of fact. Nothing further to discuss. But then Soros asks us to consider the statement "I love you"...
The statement is reflexive. It will have an effect on the object of the affections of the person making the statement and the recipient's response may then affect the feelings of the original person making the statement, changing the true value of his or her original statement.
John Maynard Keynes fell upon a similar point in 1936.
He described financial markets as a beauty contest. You are asked to judge the beauty contest, but the goal isn't to pick the contestant you judge most attractive.
Instead, you are asked to pick the contestant that you think others will judge the most attractive.
That's a different question. And if everyone is choosing who they think others will judge attractive, it starts to develop further and further layers.
As Keynes said...
It is not a case of choosing those [faces] that, to the best of one's judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.
Soros thought in those higher degrees.
Later, he lamented...
My framework was largely dismissed as the conceit of a man who had been successful in business and therefore fancies himself as a philosopher. With my theories largely ignored by academia, I began to regard myself as a failed philosopher... All that changed as a result of the financial crisis of 2008.
The Quantum Fund returned 32% in 2007, when most funds were failing.
We know this is all a bit philosophical. But it speaks directly to the current state of the markets.
Vibing on the Next Few Quarters
Recessions happen because of actions people take. And people take actions based on emotions.
Their emotions may be informed by facts, but they are emotions nonetheless.
Now, we're at a key inflection point that I've seen before in my career – but only on a few occasions.
We're at a point where prediction is nearly impossible, because reflexivity rules the market.
Right now, the economy is slowing. But what happens next depends on sentiment.
As investors and individuals come around to this slowing economy, will it sour their mood and turn slowing growth into contraction?
The recent interest-rate cut should be good for the price of stocks and other assets... but again, that's based on investor actions.
To truly tie this all up in knots, the investor reaction to interest rates will drive the stock market. And a buoyant or sinking market will feed back into the vibes about the economy.
Early signs are positive...
The University of Michigan conducts a long-running survey of consumer sentiment. Even more helpful, it publishes separate measures of how consumers feel about the economy right now (current conditions) and how they expect the economy will go over the next year (expectations).
On the chart below, you really need to focus on just the last bit of data...
The reading on the current economy is quite poor, at 61.3 versus a historical average of 91.7.
Expectations, though, are a little better. Notably, they rose in August and are up significantly over the past two years.
So consumers look to be turning a bit more optimistic about the next 12 months, making them less likely to fuel a reflexive recession...
That said, we must watch closely to ensure this confidence doesn't start to crumble.
We'll be tracking consumer sentiment and other recession indicators every week in This Week on Wall Street.
What Our Experts Are Reading and Sharing...
It's the end of an era. According to a recent Bloomberg article, legendary hedge-fund manager Steve Cohen has stepped away from trading at his family office, Point72. Cohen was the prototypical hedge-fund manager of his time (and is often cited as the inspiration behind the TV show Billions' Bobby Axelrod). My bet is that he'll be back on the trading desk before long.
Rob Spivey, our friend and director of research at our corporate affiliate Altimetry, pointed out earlier this week that the "Magnificent Seven" tech stocks are finally losing their lead over the rest of the market. Believe it or not, that's actually a healthy sign.
Sell-side analysts at banks are the ones who publish "buy" and "sell" ratings for stocks. A new study shows that they do their valuations by simply tagging a price-to-earnings ratio to a consensus earnings forecast. The point here: Buy and sell ratings from banks are not intended to guide investors – but to win business for the bank (more on that from the CFA Institute).
New Research in The Stansberry Investor Suite...
Follow the thread of lower interest rates, and it appears the Fed is trying to encourage just one thing... investment.
Lower rates encourage corporations to make bigger investments in their businesses – be it property, employees, or technology.
Now, pair that with the U.S. government's huge impetus to boost its manufacturing capacity and the advances in artificial intelligence, and you can see precisely where the money is going to flow... robots.
This month, the Stansberry Innovations Report team is giving you all the details on the future of robots.
They're not talking about humanoid robots walking among us (yet). Instead, they cover industrial robots that can assemble and manufacture goods in factories.
Projections from the ominously named International Federation of Robotics say that 718,000 industrial robots will be installed by 2026, up from 553,000 in 2022.
Heck, even Chipotle Mexican Grill (CMG) is rolling out a new robot to make guacamole in its restaurants. It's called Autocado.
In this month's issue, the Stansberry Innovations Report team highlights an investment opportunity in a Japanese company that already provides robotics to big names like Tesla, Intel, Apple, Sony, and more.
Even if you're not familiar with this company, you likely own a product built by one of its machines.
As a Stansberry Investor Suite subscriber, you can read the entire report here.
If you don't already subscribe to The Stansberry Investor Suite – and want to learn more about our new special package of research – click here.
Until next week,
Matt Weinschenk with Dr. David Eifrig
What do you think about This Week on Wall Street? Send any and all feedback to thisweek@stansberryresearch.com. We read every e-mail you send in.