As we start 2024, we turn to a pressing investment concern. Our readers must be asking the same question we are: what if we’re wrong?
We have argued that the “primary trend” in markets turned around in two moves: first, bonds topped out in July 2020; then, stocks reached their apogee at the end of the following year. We urged investors to move to MSM – “maximum safety mode” – while we awaited a crisis. Deflation was the immediate threat, not inflation. Higher interest rates would cause financing problems, we believed. Another shoe was bound to drop – a penny-loafer of a big company suddenly unable to pay its bills, a steel-toed government debt auction going “no bid”, a fast-moving crash in the stock market.
This crisis, we figured, would cause the Federal Reserve to panic: to “pivot”, lowering its key lending rate, while letting inflation rip. But what happened? So far, the bond market did as expected – with the sharpest sell-off in bond prices (and steepest increase in yields) ever seen. When the Fed began raising rates, in February 2022, its key lending rate was actually more than 5% below zero. Now, it’s more than 5% above zero in nominal terms. Adjusted for inflation, it’s about 1% or 2% positive (depending on which measure you use). The ten-year Treasury yield, on average through 2020, was under 1%. Now, it’s four times as high. Interest rates have come down recently. But they haven’t gone anywhere near the all-time lows of 2020. Inflation rates have fallen too, as expected.
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Stocks behaved more or less as we thought they would too. The market sold off in 2022. Then, after losing almost 8,000 points, in September of last year, the Dow stabilised. But then, for no apparent reason, it recovered – led by a manic performance of the Big Techs, including a bubble-like enthusiasm for AI. Then, out of the blue towards the end of last year, the Fed appeared to pivot when it halted rate rises and signalled it was planning cuts this year. No crisis. No panic. And no real reason to drop the fight against inflation – after all, core inflation is still about twice the Fed’s 2% target.
Was this then some kind of “pivot error”, or is the Fed trying to help team Biden win re-election by giving the system a little holiday cheer? We don’t know. But investors seemed to believe the good ol’ days were back again. “The long-term bull market in stocks is alive and well after the Dow hit a record high this week,” Markets Insider cheered when news of Jerome Powell’s intentions hit. Analysts expected “the long-term upside trend” to continue.
What’s going on? Is the bull market that began in August 1980 still intact, with an even higher high still ahead? Who knows? But we’d tread carefully. While stocks are up, they’re still below the highs set two years ago when measured in gold or adjusted for inflation. The lower rates of inflation we’re seeing do not mean the Fed has won its fight with rising prices. Consumer prices are still going up; just not as fast. And inflation is probably ebbing largely because the economy is slowing, not because it is getting more colour in its cheeks.
So we stand by our forecast. All we have so far is a “weak pivot”. No major crisis. No decisive swing to lower interest rates and higher inflation. Is it time to get out of cash? Time to switch out of “maximum safety mode”? Where would you go – to stocks…when they are at all-time highs? To bonds…just as the US has its biggest monthly deficit ever? No, we wouldn’t abandon safety mode. Not yet.
This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.