A New Reality Is Starting to Set In
Financial gravity at work... 'Come back to Earth'... Interest rates matter... What's going on with bonds... A new reality is starting to set in... Are we overlooking a food crisis?... Some good news: A new survival plan is coming...
We begin today with a note about financial 'gravity'...
We, along with many others with money in the markets, were "Fed watching" again today... For better or worse, what the Federal Reserve does, specifically with interest-rate policy, matters... and probably too much.
Here's what famed investor Warren Buffett said back in 2013... and other times since then... when the world was still trying to figure out how to deal with "quantitative easing" paired with rock-bottom interest rates (which is still here a decade later)...
Interest rates are to asset prices what gravity is to the apple. They power everything in the economic universe... When there are low interest rates, there is a very low gravitational pull on asset prices.
The opposite is also true... When interest rates go higher, as dictated by the Fed, there's a stronger pull "back to Earth" for stocks, bonds, and any other assets with a connection to our debt-loaded, dollar-based financial system.
We could spend a long time getting "into the weeds," as they say, about why this is, but today, I (Corey McLaughlin) mostly want to invite you to accept Buffett's law as a fact of financial life, so we can move on to the relevant new details of today...
Today, the Fed said, 'Come back down to Earth – a little bit'...
Well, nobody actually said anything, but the minutes from the Fed's most recent March meeting were released to the public and essentially indicated... We're going to be more "aggressive" to try to slow inflation.
The notes showed the potential for multiple 50-basis-point, or 0.50%, rate hikes this year and that Fed officials "generally agreed" on starting to roll off $60 billion in Treasurys and $35 billion in mortgage-backed securities from its balance sheet for three months starting in May.
That would be about twice as fast a pull-back, which the Fed did from 2017 to 2019. Plus, while the 0.50% rate hike is now commonly expected, it's important to note the central bank has not put a "double hike" – compared with the standard 0.25% tinker – into action since 2000.
Now, the Fed is talking about doing it more than once in the next nine months. Nobody knows what that looks like entirely...
What's more, indirectly and left unsaid, these moves will likely slow economic growth. This is why, as we noted last Friday, folks are concerned about a recession within the next year or two...
A new reality is starting to set in...
As much as we would be happy never to write the words 'Federal Reserve' again...
We can't ignore the fact that whatever the central bank does – or doesn't do – is going to matter big-time to the direction of the markets in the short and the long term...
Making money "more expensive" – or the dollar relatively stronger – triggers changes in everything... mortgage rates, car loans, and how Wall Street institutional investors value the future cash flows of stocks and other investments...
If you want to go down a rabbit hole, search "discount rate" in our archives and find the work of our editors on this point... and we'll surely get into it more down the road here.
For now, in the short run, the trimming of the balance sheet is one big part of the Fed's string-pulling... and the pace of expected interest-rate hikes is the biggest... Both policies will ultimately show up in the movement of stock and bond prices.
Today, after the nitty-gritty of the central bankers' meeting went public, the major U.S. stock indexes started selling off. For the second straight day, the tech-heavy and growth-sensitive Nasdaq Composite Index closed down 2%...
Meanwhile, more "boring" always in-demand sectors such utilities, health care, and consumer staples were each up more than 1.5% today. One or two days doesn't make a trend, of course, but we're watching how Mr. Market reacts to this new Fed-speak closely...
As for bonds, keep watching them too...
As our Stansberry NewsWire editor C. Scott Garliss said today, he's watching the 10-year U.S. Treasury yield closely, as a helpful indicator of "near-term market sentiment"...
Bonds are widely considered a "risk free" government-backed investment, and thus demand for them signals how investors are feeling about risk in the economy. That's why an "inverted yield" curve, as we've been talking about here, is a big deal...
Scott, who worked on Wall Street for two decades before joining Stansberry Research, wrote that money managers and hedge-fund traders are worried that rapidly rising interest rates and a shrinking Fed balance sheet will raise borrowing costs significantly...
Wall Street's concerned that corporations and households have become addicted to the low cost of borrowing since the financial crisis in 2008-09. They're unsure that consumers can manage any significant increase in yields and the costs associated.
Since the 10-year U.S. Treasury yield is the benchmark rate for all types of loans, hedge funds will pay attention to the moves in that rate for clues about economic output potential and the direction of the stock market.
Take a look at the following chart of the S&P 500 Index compared to the 10-year yield. You can see rising yields have weighed on stocks...
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Rising borrowing costs mean more money being paid to service debt. Any companies that have bonds maturing in the next 12 months will plan to roll those loans over. But, if the Federal Reserve raises the federal-funds target range to 2% or more, it could mean higher interest payments. The change would eat into corporate profitability.
The same goes for households, Scott noted... Those with credit-card debt or variable-rate mortgages are looking at a similar situation. The rates of interest paid on those loans will fluctuate with the federal-funds target rate.
As we wrote last week, fixed mortgage rates have already been climbing fast and the average interest rate on a 20-year home loan is near 5%. More from Scott...
So, as inflation worries mount, we'll want to keep watching the yield on the 10-year. The more it rises, the more it will cost for individuals, households, and companies to cover costs. Over time, the change begins to show up in the form of less demand for all types of goods.
As demand for goods dries up, so do revenues and earnings for all types of companies. Food and gas costs will eat up more of people's discretionary income. Consequently, the need for the latest, greatest technology gadgets falls.
The shift begins to play out in the form of declining earnings estimates for indexes like the S&P 500 and Nasdaq Composite Index.
This upcoming earnings season, reflecting the first quarter of the 2022 calendar year, will be one of the biggest to watch over the last few years, and we will continue to check in with Scott and his team on the NewsWire...
Since the depths of the pandemic lockdowns, companies have largely exceeded Wall Street analyst expectations and beaten quarterly estimates. But we're in a new environment now...
Moving on, to another disturbing effect of the war in Ukraine...
Picking up where we left off yesterday... on how "what happens in Russia does not stay in Russia"... our Stansberry NewsWire analyst Daniel Smoot wrote an interesting analysis today on rising global food costs stemming from the war...
In short, Russia's invasion of Ukraine ‒ and the reactions to it ‒ is now just starting to increase food costs around the world...
This is one of those second- and third-order concerns that we shared via Jim Rickards yesterday and wrote about at the onset of the conflict in Eastern Europe. As Daniel wrote today...
Together, Russia and Ukraine export 28% of the global fertilizer supply. And they're major contributors to wheat production and exports as well.
But with the closure of businesses in the region – as well as tough sanctions by the West – the world has seen a substantial decrease in commodity supply. Consequently, farmers and food companies worldwide are facing increased pressure.
The cost of raw materials used for fertilizer, like potash, has surged by 30% this year. Turns out, Russia and neighboring (and similarly sanctioned) Belarus have been responsible for 40% of the world's potash exports.
We're talking about almost half of the world's supply of a key ingredient for fertilizer being in jeopardy of getting where it has normally gone. As Daniel concluded...
This is amplifying broader supply-chain concerns, as it remains unclear as to how long the conflict will continue. So, as the situation further unfolds, we'll likely see farmers and companies like General Mills (GIS) hike prices to account for increased overhead.
But while this will help mitigate some business disruptions, the higher costs will be placed on consumers – potentially exacerbating global inflation.
Is the world overlooking the consequences of the war on the global food supply? It seems that way. In this note, we just focused on fertilizer... but don't forget that roughly one-third of global wheat supply is sourced from Eastern Europe.
As we wrote on Monday, the longer the war drags on, the more fuel for inflation and, in general, obstacles for economic growth we're likely to see.
In other words, now might not be the best time to take on new risks in stocks if you are in search of short-term gains... That said, the best long-term buying opportunities also typically occur when the world is losing its collective mind, as is the case right now.
Some good news: a new solution for our crazy times...
As I mentioned on Friday, our team is putting together an all-new Stansberry Research "Financial Survival Guide," with a series of actionable lessons and tips on what you can do to protect and even grow your money in this market.
Without giving too much away, I can tell you that we're compiling a variety of approaches to protecting your wealth and making money in the current environment. I'll have more details about how to access this new product in Friday's Digest. Stay tuned.
In the meantime, be on the lookout for Dan Ferris' weekly missive in this space tomorrow, rather than the last day of the week...
Let's Expose Some Big Banks
Matt McCall sees a common trait among three of the world's largest investment banks... They have no consensus on where stocks are headed the rest of the year...
As Matt says, some are far behind the curve with their predictions, while others are flat-out making up statistics. In his latest Making Money With Matt McCall podcast, Matt exposes the lies...
Click here to watch or listen to this episode right now. And to catch all of Matt's shows and more videos and podcasts from the Stansberry Research team, be sure to visit our Stansberry Investor platform anytime.
New 52-week highs (as of 4/5/22): Bristol-Myers Squibb (BMY), Virtu Financial (VIRT), Westlake Chemical Partners (WLKP), and Walmart (WMT).
In today's mailbag, the conversation continues about the plans to tap the Strategic Petroleum Reserve, stemming from a comment in yesterday's mailbag... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"Even if Biden can get this oil into the domestic market it won't amount to a hill of beans. The word I received was it would make about a 20-cents difference in a gallon of gas. Whoopie... that doesn't even get us back the net effect of our high inflation. And when it comes to replacing the oil they took out, they are going to have to pay $120 or more a barrel.
"Furthermore, what happens if we need that oil in the event of a future military conflict with Russia sometime in the next six months or so? That's [why] the oil was placed there in the first place. Just another bungled plan that was not thought out well.
"If the White House had not started a war with the domestic oil companies, we would not be in this mess to begin with. Oil is not going away any time soon, even with all the political noise about [global warming] and our push to become 'all electric.' It will be a slow, grinding process to get there." – Paid-up subscriber John M.
All the best,
Corey McLaughlin
Baltimore, Maryland
April 6, 2022