By: Carter E. Anthony, CFA
Investment banking firms Morgan Stanley and Blackrock analysts are sounding the alarm that stock market valuations and economic fundamentals aren’t in sync.
According to their analysts, the stock market is disconnected from reality. In other words, we are in a “bear market rally”.
Investors are assuming the decline from a 9.1% CPI in June to an 8.5% CPI in July will cause the Fed to pause its interest rate increases.
Stock market indices climbed about 20% from June lows in the face of declining home sales and auto sales, two of the most important GDP indicators.
Cutting inflation out of the economy has a long way to go especially with an administration that has no idea how inflation is created.
Keeping interest rates historically low after the Great Recession for more than a decade fanned the flames of inflation and throwing money out on the street during the pandemic added fuel to the fire.
To curtail double digit inflation in 1980, Fed Chairman Volcker raised the Fed Funds rate to 20% causing all other interest rates to rise and any growth in the economy to die.
Much of the blame for that inflation can be laid at the feet of President Johnson who escalated the Vietnam War.
He mortgaged the country’s future by financing the war with debt under his “Guns and Butter” policies.
He said there was no reason for the American people to suffer while our soldiers were trying to save a nation half way across the world from Communism.
He didn’t seem to think about the families’ suffering from thousands of lives lost. At least we don’t have a war going on half way around the world where politicians might send our young men and women.
As has been said before, some see a recession as a natural phenomenon. Economies grow too fast for too long, no new products are being introduced, consumers, which make up 70% of GDP, grow weary of spending, consuming, pull back and a recession ensues.
Such is a market-driven cure. On the other hand, the Fed can keep interest rates too low, too long, artificially encouraging growth and consumption creating inflation.
And so, the Fed feels the need to curtail inflation using the only tool in its toolbox, increasing interest rates.
As I have said many times before, the Fed should have normalized interest rates several years after the Great Recession but it’s awfully hard for a presidential appointee to throw water on an economy on fire.
Are we in a recession? The most important indicator is the change in the Gross Domestic Product, the total market value of all final goods and services produced in the U. S. in a given period of time.
The downturn in the GDP for the first and second quarters historically indicates a recession.
Strong indicators within the GDP include existing home sales which are down 20% year over year.
Real income earned is down 3% year over year. Retail sales, 20% of which are auto sales, are up 8% year over year, barely in line with inflation.
Unemployment is low but it is complicated by the job participation rate which is 5% below the pre-pandemic rate.
A better look at unemployment is jobless claims which are at an 8-month high.
On the bright side, Industrial Production, which includes manufacturing, mining and utilities, all sensitive to interest rates and consumer demand, is up 3.90% year over year.
The University of Michigan’s Consumer Sentiment Index in July rose 5 points above its lowest level ever in June.
Read that again! “Five points above its lowest level ever in June”. That’s almost like being happy regular gas has fallen to $3.50 from $4.90 earlier this year although it was $2.39 at President Biden’s inauguration.
Are we in a recession or headed into one? Yes! The question is how deep will it be?