Last Call for Easy Money and How to Prepare for What's Next
Wall Street got spooked... Last call for easy money and how to prepare for what's next... The time to prepare is now... The power of 'second-order thinking'... When bulls are contrarians...
Very rarely do boring government-meeting minutes move markets...
But a few times a year, it happens... Yesterday was one of those days.
The tech-heavy Nasdaq Composite Index and small-cap Russell 2000 Index each slid 3.3%... And the benchmark S&P 500 Index and good ol' Dow Jones Industrial Average were not immune either ‒ down roughly 2% and 1%, respectively...
The reason, according to (take your pick of the mainstream headlines), was the nitty-gritty of the Federal Reserve's December meeting. Yesterday was the day the minutes were shared publicly, as they typically are weeks after said meetings...
For all of the details on what was said in those minutes, I (Corey McLaughlin) recommend you read Stansberry NewsWire editor C. Scott Garliss' report here.
But long story short, the central bank is getting more 'hawkish'...
What's hawkish?... Wall Street loves its animal analogies – bulls, bears, black swans. For the newbies, hawkish usually refers to preferring "tighter" monetary policy, like higher interest rates to fight inflation. Doves like "looser" policy.
At its December meeting, the Fed folks talked about acting like hawks ‒ meaning hiking interest rates from near zero a few times in 2022 until they reach a range of 1.5% to 1.75% by the end of 2023.
Not only that... but they also are thinking about trimming the Fed's balance sheet more or less at the same time.
And Fed members think it might be a good idea to act on this quicker than they did after the financial crisis in 2009... the last time we were firehosing funds into the economy to see what would happen.
According to Scott...
This is what spooked Wall Street...
Members agreed it would be appropriate to commence shrinking the balance sheet sooner than the two-year time horizon last time. They said it would happen sometime after the first rate hike, but the decision remains data-dependent.
Right now, the Fed has simply decided to lower the amount of assets it's buying each month... but it's still buying them nonetheless ‒ $90 billion of bonds and mortgage-backed securities last month and $60 billion this month. So the balance sheet is actually still growing... just not by as much as it has been.
The purchases are slowing down, but the "easy money" policy is well entrenched...
That's probably going to change this year, possibly as early as the next big Fed meeting in March.
Which leads us to our big point today...
It's probably wise for you to prepare for a "hawkish" ride in the stock market in 2022...
As a few of our editors have talked and written about lately, that could mean a wild, volatile trip in the short term... but it might not be as bad as the headlines imply it will be over the long run.
In any case, consider now 'last call' for easy money...
If you missed it, inflation is now officially not "transitory," according to Fed Chair Jerome Powell... He slipped that mea culpa into public record a few weeks ago.
So with that out of the way, now the central bank will pull out its blunt tools to try to fight inflation. The biggest tool in its box is raising interest rates...
The reasoning is that the Fed raising rates makes borrowing money throughout the economy more expensive.
That partly explains the recent tech-stock sell-off ‒ the idea being that tech companies rely on borrowed money more than other companies because they need to invest in growth... Whether this is true is another story and up for debate.
The broader truth that applies here though is that Wall Street, and our monetary system in general, doesn't like anyone messing with its addiction to debt.
Still, if anyone was selling based on the Fed minutes alone yesterday, I question it...
As with any decision, there are often a few reasons beyond the simple ones that fit nicely into headlines... like goals, time horizons, a deal happening, etc.
But if we know a few things, we know...
- If people do trade based on what's in the mainstream headlines, they are last to the party. As an example, Wall Street pioneer and Chaikin Analytics founder Marc Chaikin pointed this out to us most recently while showing us his tool, which reveals what Wall Street is buying and selling long before most people notice it.
- For whatever reason, any Fed move typically spooks or sparks Mr. Market no matter what we think about any of this.
And there will be many, many headlines this year about the Fed hiking rates and "tightening" policy... more than there have been already.
And there will be more than there have been since 2018, when the central bank last consistently raised its benchmark interest rate up to what now feels like an astronomical 2.5%. It has been near zero since March 2020.
So it's wise to think about what this means for your portfolio...
If you're a short-term trader, it might be very fun and lucrative if you know what you are doing when it comes to options, for instance. Greg Diamond's work in Ten Stock Trader and our colleague Dr. David "Doc" Eifrig's Retirement Trader and Advanced Options services are great places to find guidance.
At the same time, if your portfolio is set up for the long term with a lot of stocks, you might have more of those bite-your-lip and chew-your-fingernails kind of days than we've had since March 2020...
This is why you want to prepare now. You can't put a price on priming your emotions for what's to come... And practically speaking, looking around the next corner when thinking about what to do with your portfolio now can pay off big time down the road.
The most 'obvious' takeaway and the surprise...
So now, we are entering a world where the Fed isn't flooding the market with out-of-thin-air money... Thus its benchmark rate-related yields are rising, and subsequently the prices of bonds will go down. (When yields rise, bond prices go down, and vice versa.)
So on the bright side... higher interest rates give investors more choices for what to do with their capital.
When rates are low, stocks are the best bet. There is no alternative...
It doesn't make sense to own bonds when yields are near zero. But when interest rates rise, those higher-yielding bonds become more attractive and start to pull dollars away from the stock market... meaning trouble for stocks.
But there's just one problem with this line of thinking...
As Dr. Steve Sjuggerud wrote in the December issue of his flagship True Wealth newsletter, this is "first-level thinking." It's the obvious. It's the herd mentality... And it wasn't true at all the last time we saw this situation in 2013 and 2014 post-financial crisis.
Steve said if you want to make outsized returns in the market, you want to use "second-level thinking," an idea that investor Howard Marks wrote about in his book The Most Important Thing...
First-level thinking says, "The outlook calls for low growth and rising inflation. Let's dump our stocks."
Second-level thinking says, "The outlook stinks, but everyone else is selling in panic. Buy!"
The "obvious" trade now is that if the Fed tightens, stocks should suffer... That might be true to some extent, but maybe not in the form, scale, or timeline you might think.
We don't have to go too far back to see relevant precedent...
The Fed started a similar path of tightening in 2013 coming out of the financial crisis. You might remember the "taper tantrum"...
That's the name given to the market's reaction to then-Fed Chair Ben Bernanke mentioning in a May 2013 Congressional hearing... without clearly signaling it in advance... that the central bank could cut bond purchases at some point in the future.
Bond investors were spooked about this possibility... Some panicked, selling bonds, which in turn spiked yields.
But based on how this event is talked about by critics today, you'd also think that it led to a massive sell-off in stocks... But that wasn't the case.
Bond volatility was significant, to be sure ‒ and there was a brief pullback of close to 6% in the S&P 500 over about a month around Taper Talk Day... But stocks rebounded more than 18% into the end of the year... before the tapering even happened.
Once it began in December 2013, stocks rose another 23% by the time the bond-buying program ended in October 2014. As Steve wrote last month...
First-level thinking said that stocks should have suffered. But second-level thinking said that was what everyone would have already expected... and more important, that the fundamental picture hadn't changed. Stocks could continue soaring. And that's exactly what happened.
We have a similar setup in the market now...
The timelines might be different now, and the Fed could always get too aggressive and raise rates too fast and by too much and really mess up the economy...
But the point today is... if your knee-jerk reaction is to go "all out" of stocks because of what the Fed might do soon, think again.
First off, the economy is actually strong...
This is the forgotten fact in this whole discussion. Consumer spending, which makes up 70% of our economy, is strong and above pre-pandemic levels... and wages have been increasing.
As Scott wrote yesterday...
Look, the economy has seen a tremendous rebound since the lows in March of 2020. The pace of growth is well ahead of what the country experienced prior to the coronavirus pandemic. According to U.S. Bureau of Economic Analysis data, we're on track for average growth of around 3.5% per year over the last two years compared with a 2.3% average from 2009 to 2019.
So, easy-money policies have been a big driver of the rebound. They're a crisis tool and the crisis is over. Removing them doesn't mean the economy is about to crater... It means the economy is healthy.
That's why the Fed is in a position to "pull back," so it can jump back in with stimulus the next time a crisis strikes. And as Scott said, a Powell-led Fed has been very deliberate in its communication and moves for the last several years...
The central bank is unlikely to raise rates so abruptly overnight. Its opinion didn't change in the release of these comments from mid-December. Policy tightening will be gradual and drawn out.
Even if the Fed does misstep along the way, and we won't put it past them, the shock to the system could be short-lived.
A recent Bloomberg survey of 500 different analyst predictions for 2022 showed inflation is the hottest topic right now, most people expect interest rates to increase this year, and a lot of analysts believe the Fed will mishandle policy decisions somehow...
In the big picture, investors are ready for a Year of the Hawk... We want you to be, too.
Today, believe it or not, a contrarian idea is that stocks will rise in the face of Fed tightening policy, but history suggests that's exactly what will happen.
A Six-Pack of Picks for 2022
In the first Making Money With Matt McCall of the new year, Matt takes a look at all the Wall Street predictions for 2022 that he's seeing... he talks about Apple (AAPL) hitting a $3 trillion valuation... and shares a diverse six-pack of stocks best positioned to become the next half-trillion-dollar companies.
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 1/5/22): Berkshire Hathaway (BRK-B), CVS Health (CVS), Flower Foods (FLO), Hershey (HSY), Kimberly-Clark (KMB), Coca-Cola (KO), McCormick (MKC), and Procter & Gamble (PG).
In today's mailbag, more feedback on the latest COVID wave and Tuesday's Digest about measuring portfolio risk... Do you have a comment or question? E-mail us at feedback@stansberryresearch.com.
"Corey, Glad to hear that you and your family did well with COVID. And I see it has brought out the 'vaccines are useless' crowd in the mailbag. How about you guys publish something from the other point of view? Maybe I'm the lone voice crying in the Stansberry wilderness. I'll give you two points to ponder.
"1) In Ohio, the state medical board sent out an email update 12/30. It reported that since June 1st, there had been 35,962 hospitalizations from COVID, and 92.5 percent were unvaccinated. It also reported that 63 percent of the eligible population had received at least one dose of vaccine. So the way I read those figures is the 37 percent of the population is producing 92.5 percent of the hospital admissions. Doesn't sound 'useless' to me.
"2) As a practicing doctor, I have seen people with breakthrough infections who are vaccinated. Many are older with multiple medical issues. Most, not all, have had mild illnesses and recovered. I haven't seen many treatments that require perfection to be considered 'useful.'
"Here is a bonus point – As our county coroner, I deal frequently with funeral directors. They are exhausted, swamped dealing with the COVID deaths. They're not looking forward to this winter surge. New Year's Day I had my first coroner call of the year – a COVID death." – Stansberry Alliance member Douglas V.
"Hello Corey, Thank you for this article on risk sizing... This kind of simple basic tool is very useful.
"As always, I read the feedback section. If that was the type of feedback you got after the COVID article, I wanted to let you know that there are also readers who trust science and scientists. All the best for the new year." – Paid-up subscriber Riitta R.
All the best,
Corey McLaughlin
Baltimore, Maryland
January 6, 2022