Investors need to beware and not blindly ignore a possible day of reckoning. The situation is this. The economy got overheated from government spending and Russia’s war to take over Ukraine. Inflation rose to levels not seen in four decades. Thus, the Federal Reserve started to reduce their balance sheet and raise interest rates every month. This is how the Fed fights inflation and the end result is almost always a recession that drives stock prices down. The market, however, is acting right now like the worst is over and the Nasdaq is up 20% over the last month or so. The Dow is up a couple of percent and the S&P 500 is up about 15% since late December 2022. Folks at the Bank of America warn investors not to sleepwalk into a selloff.
How Did We Get Inflation and a Possible Recession?
The US (two Congresses, the Federal Reserve, and two Presidents) stimulated the economy with lots of free money in order to keep the economy from a total collapse during the Covid pandemic. Before that the Trump tax cut poured money into the pockets of wealthy stockholders while adding $2.3 trillion to the debt over the following decade. And legislation to repair America’s infrastructure and bring critical industries back onshore are still pouring more money into the economy. The result has been the highest inflation in four decades. After dragging their feet a bit, the Federal Reserve started raising rates in March of 2022 and continued throughout the year. While rate hikes are eventually effective in slowing the economy and lowering inflation, the Fed will, more often than not, drive the economy into a recession before the job of lowering inflation is accomplished.
Where Is Business Going in 2023?
Ignore interest rates and a possible recession for a moment and just take a look at the big tech companies that fueled the bull market for more than a decade after the Financial Crisis. Amazon.com made history recently as the first company to lose $1 trillion in market cap. The New York Times Dealbook writes that big tech companies Amazon, Apple, and Alphabet all had “disappointing” earnings recently and are cutting costs as they go into a new-for-them austerity mode. These folks believe their financials as business drops off. These folks believe central bankers from the Fed and across the world who say repeatedly that they are not done raising interest rates and that there will be some economic pain before they are done. They believe statistics of things like a big drop in sales of personal computers which has, in turn, hurt chip makers.
Good News for Workers Is Bad News for an Overpriced Market
While the market engaged in wishful thinking that the Fed is almost done raising rates, the monthly jobs report came out with a surprising increase in 517,000 jobs in January which brings the unemployment rate down to the lowest since 1969. This is excellent news for folks who were looking for work and should be a wakeup call for folks expecting the Fed to stop raising rates. Although no one in the Federal Reserve likes the idea of businesses losing money or folks losing their jobs, that is very possible as the Fed continues to raise rates. The worry for the market is that investors will wake up too late, having poured money into a rally that was a mirage. As investors blindly ignore a possible day of reckoning, it becomes increasingly likely that the market will panic at a downturn and suffer much worse than the economy should Fed interest rate policy finally solve the inflation issue by driving the economy into an “official” recession.
Investors Blindly Ignore a Possible Day of Reckoning – SlideShare Version