FWIW # 36 - The Future

The Fed paused raising interest rates, and the stock market immediately declined then rose the next day. Now you know why (1) money managers who try to play Wall Street’s game of guessing the future are doomed to fail, (2) once a good company is in your portfolio, you should act as an owner and not a speculator, and (3) collecting steady cash flow boosts your compounding returns. The stock market is on a rapid rise, at least for this time of the year. The pundits can all pontificate in the media as to why we’re having a soft landing, interest rates are going down soon, and the infrastructure and Green New Deal bill (also mistakenly called the Inflation Reduction Act) are being given credit for the stock market’s rise. They are mostly wrong. The rise in stocks involves many factors pushing prices higher, but the main impetus is coming from the Fed and Wall Street traders.

Investors and speculators (they aren’t the same people, no matter what the business media says) are acknowledging that the Fed has capitulated on their avowed task to wring inflation out of the economy. The pause from raising interest rates has been offset by the Fed’s aggressive statement that they will raise rates twice later this year. If that’s the case, why not do it now? There’s no logical answer to that question other than politics. Everyone hailing a 4% inflation rate is ignoring the significant familial and societal damage inflation at 4% is doing to lower-income and middle-class Americans. This pause is similar to the pause the Fed took in the early 1970s that helped embed inflation in the economy, leading to higher inflation and thus additional rate rises, culminating in Paul Volcker doing what prior Fed Chairs would not do, but what was necessary: stop managing interest rates and manage the growth in the money supply, allowing the market to set interest rates based on the supply and demand of a controlled money supply. Even then, it took almost 30 years to eradicate inflation. The current Fed is controlled by the political process. The current administration has put a significant number of current Fed governors in office. Their leanings are toward easy money, i.e., lower interest rates and more inflation It’s hard to believe the Fed will be raising interest rates as we get closer to the crucial 2024 presidential election.

The stock market understands this as a signal from the Fed that unacceptable inflation will continue for longer than anyone expects. That’s good for stock prices because the inflation-boosted revenues will eventually lead to inflation-incorporated profits as businesses pass on the impact of higher inflation costs to their customers. The only people who suffer during these times are retired people on a fixed income, lower-income workers, and middle-class salaried workers. Inflation is a tax on a population by government officials who don’t have the integrity to raise taxes and suffer the consequences, if there are any.

Even more important than the Fed’s capitulation to the political elites by pausing interest rate increases is the chilling signal from the Fed that interest rates will be lower this time next year and the year after that. How do they know this? They know because they intend to continue managing interest rates rather than allowing the market to set rates. That signal translates into a greater money supply than necessary, which translates into higher than acceptable inflation.

There will be periods when the stock market declines. Volatility is designed and manufactured by Wall Street traders to give them trading profits. They manipulate the public speculators as if they were playing with a yo-yo. Owning stocks are necessary to maintain your net worth’s purchasing power. Adding to your holdings requires paying some attention to the markets. Whenever there is a bubble or favorite few stocks, such as we have now, money has left other stocks or sectors. These are what I call potholes, the opposite of bubbles. That’s what you should be looking for: fairly valued stocks that fill any glaring, underrepresented economic sectors in your portfolio.

A stock market crash is dependent on a massive wave of speculators selling. This type of event is brought about through sudden and unexpected changes in credit or displacements in the economy that lead to a restriction in available money. With the evolution since 1995 of an activist Fed attempting to dampen the natural business cycle, the amount of monetary expansion and credit support the Fed has had to deploy to stymie the effects of a negative economic event has risen. At some point, the Fed will not be able to intervene and minimize the impact of economic dislocation. It’s inevitable, but no one knows when the country or world will pass that point. Waiting for a disaster is not logical. Knowing what companies fit in your portfolio and what price is a fair price to buy at makes sense. This sounds like a broken record, but it’s important to understand and implement.

The fixed income markets continue to reflect the disbelief by the broad market participants that interest rates will stay at their current levels. It’s only someone who hasn’t studied financial history who believes that interest rates are high. The ten-year US Treasury note at 3.75% is at the bottom of its 1820-2010 range, prior to the aggressive Fed policies of the last 12 years. The Fed is at fault for the inverted yield curve. If they announced today that they were changing policies and will manage the money supply, jobs would not disappear, GDP and productivity would go up, and the yield curve would lose its inversion as short rates come down and longer rates move upward with the longest rate being the highest. How and why do I make these claims? First, corporate senior management believes the Fed is deliberately raising interest rates to decelerate the economy, which causes them to slow their expansion and capital projects, incorporate inflation into their plans, think about possible layoffs due to a coming recession, and generally have a pessimistic attitude about future business. When interest rates rise, the return on investment (ROI) of any project must increase to accommodate the higher cost of capital. This ROI dilemma affects everyone doing business. If the Fed changed policies to manage the money supply and let the market set interest rates, then well-managed businesses would have a lower cost of capital than the zombie companies or hair-brain schemes that should not and cannot survive. So, the managed money supply would help the productive parts of the economy and stifle the nonsensical businesses instead of negatively impacting the whole economy. Let’s hope the Fed ignores their political manipulators and returns to sensible monetary policy.

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On another matter, the rage today is generative AI (GAI). Several leading thinkers believe there should be a pause in developing GAI while regulators build “guardrails” to guide the development of GAI. That’s foolish. The genie is out of the bottle. GAI is going to be developed by bad actors as well as good actors. While the US is doing nonsensical things like building into the language models the prohibition of using certain words and phrases or subject matters, the bad actors of the world, and I don’t just mean other governments, will build GAI capabilities to move toward controlling governments and societal infrastructure. The only way to ensure freedom going forward is for good actors and governments to have the most complete and complex GAI on earth. Even then, there’s no guarantee the people running the government and GAI system won’t be corrupted by the power they possess. Think about the age-old saying: “Power corrupts. Absolute power corrupts absolutely.” Transnational criminals have massive amounts of disposable resources, even more than most governments. If they choose to continue cooperating with each other, as they have been for a number of years, serious implications will grow as GAI is developed. More on this as time goes by.