Stocks rose Friday after a dovish speech by Federal Reserve Chairman Jerome Powell. While his forecast that the Fed would begin to slow the pace of bond purchases before the end of this year was on target with consensus, his statement that the time to think about raising short-term rates was a long way off was certainly comforting to those hoping rates would stay near zero for a long time.
Fed policy, over time, will be predicated on inflation and expectations of future price increases. Mr. Powell and others on the FOMC are holding to the conclusion that much of current inflationary pressures will evaporate over the next year. Some is fairly obvious. We already see declines in some commodities like lumber, copper and oil after supply caught up with the post-quarantine surge in demand. What is less obvious are all the price increases tied in some way to the supply chain disruptions. Some, including Mr. Powell, feel most of these imbalances will be corrected over the next several months halting pressure to raise prices further. Some disagree. They believe demand strength is more enduring. Supply may catch up enough to halt the outright shortages, but pricing power will remain in the hands of the sellers, not the buyers. The focus here will be on the pace of wage and rent increases over a longer 1-2 year span.
The market is clearly taking sides, aligning with Mr. Powell and the Fed. Interest rates all along the yield curve remain low. Is that because investors buy the Fed’s theory that inflation is transient, or because massive bond purchases are keeping rates depressed? Obviously, as tapering begins, we will learn more.
For now, it’s hard to fight the Fed. Rates are low with little upward pressure. They may rise a bit, but not enough to slow the advance in stock prices or other asset values. The ongoing recovery in bitcoin, other crypto currencies, meme stocks, and, yes, even some SPACs is testimony to the power of excess money chasing a limited number of assets.
Some, like myself, are skeptical of the long-term value of these speculative assets. Many (most?) have little obvious intrinsic value, but prices at any moment in time are a function of supply and demand. I have no idea whether bitcoin will sell for $10,000 or $100,000 six months from now. There are no fundamental metrics I can use to calculate fair value, but buying bitcoin today isn’t a result of any calculation. It is simply a belief that prices will go higher, that someone will pay you more tomorrow than what you paid for it yesterday. The same goes for SPACs, meme stocks, art attached to a NFT, or any other speculative investment of choice. The fact that all are rising again is simply an affirmation that, for the moment, there are more speculators willing to buy. Speculation percolates when optimism surges along with rising savings and a rapid expansion of the money supply. All those conditions are met today.
The same concept applies to the overall market. They aren’t completely detached. Friday, the Fed said that they will keep buying bonds, and keep adding cash to the market for many more months. In the long run, valuation matters, but not necessarily today or tomorrow. Excess cash, savings and money are the only reasons for rising asset prices. They have been a dominant factor for the past decade plus.
So, what is an investor, not a speculator, to do?
First, don’t fight the Fed. If the Fed is continuing to pump money into markets, even at a slow reduced rate, the likelihood is that, all things being equal, prices will keep rising. Second, earnings are still increasing and the economy is strong. Delta variant is peaking. I know the evening news continues to present horror stories, but horror stories are what attract viewers. Soon, case counts will start to fall. Within two months it will be highly visible. Within two months, boosters will provide more immunity. Delta only helps to accelerate the push toward herd immunity. Today’s fears won’t last. The market understands this.
The party has an ending. By the end of 2022, the Fed will, hopefully, be done buying bonds. Other central banks will follow. We don’t know what taxes will be or what Congress might or might not pass. Investors hope nothing passes, but that is a hope not an expectation. Slower growth and limited money supply growth will elicit a more subdued investor response.
The reality is that there is a lot of uncertainty, particularly if one looks to the second half of 2022 and beyond. What will Congress pass? What will be paid for? What will interest rates be once the Fed is no longer buying bonds?
The best response is to stick to your asset allocation, one based on your needs, not simply on what the market is likely to do. The key to real portfolio management is not to get caught up in the euphoria of a bull market or go into lockdown in a bear market missing a once in a generation opportunity. If you stick to your asset allocation, you sell stocks when they are high and buy them when they are low. You move in baby steps, not all at once. The phrase “portfolio management” suggests a game plan, discipline, and the ability to adapt to change. It’s the core of successful investing. Visualizing what is over the horizon is harder than looking at a snapshot of today.
Our crystal ball doesn’t see recession any time soon, but it doesn’t see persistent strong tailwinds either. Stocks typically rise 7-9% per year. 2021 is likely to be the third consecutive year where stocks rise at twice that rate or more. It is unreasonable to expect more of the same. How markets adjust to a new tomorrow, one without Fed intervention, is the quandary we all face. But for now, the ride isn’t over. The Fed will still be pumping money in for at least another year. There is no reason to fight the Fed now, but there are reasons to be sober about the long-term picture.
Today, Cameron Diaz is 49. Warren Buffett turns 91.
James M. Meyer, CFA 610-260-2220