29 Jan R.I.P. TINA?

“Is America’s love affair with TINA finally coming to an end?” –The Lonely Realist

As TLR has highlighted repeatedly over the past three years (most recently in October 2020, May 2021 and September 2021), although the Federal Reserve has the ability to deflate inflationary pressures by removing the metaphorical punch bowl when the inflationary party gets out of hand (a reference to former Fed Chair William McChesney Martin’s 1955 description of the Fed’s role), it will be reluctant to do so, recognizing that anti-inflationary action necessarily stunts economic growth and rattles markets. The Fed accordingly has been doing the opposite for the last dozen years, constantly refilling the punch bowl – via dollar-printing –, driving economic expansion and America’s love affair with TINA – There Is No Alternative to the ownership of stocks. In doing so, the Fed has followed a highly accommodative fiscal policy that has taken both markets and the economy to record levels. Its furious pace of punch-spiking was enhanced by tax reductions enacted in 2017 and generous government anti-COVID stimulus in 2020 and 2021. The cumulative effect of highly accommodative Federal Reserve policy and Trump/Biden Administration largesse was to super-charge asset inflation. When coupled with COVID-triggered supply chain issues, they’ve ignited price inflation. The Biden Administration has added an after-burner effect via employment policies that have boosted wages and, consequently, wage inflation. The Consumer Price Index now is at a level not seen since the 1980s.

This potent fiscal expansionism has fueled America’s love affair with TINA.

But by the middle of 2021, the Fed was beginning to have second thoughts, talking down fiscal accommodation, although simultaneously dismissing the early signs of inflation as “transitory.” It was forced to abandon its transitory narrative in November as inflation reached headline levels (it was approaching 7% and reached that level in December, far above the Fed’s 2% target), declaring that it would gradually phase out its $120 billion/month of bond buying and consider raising interest rates (so-called “lift-off”) during the second half of 2022. If the Fed believed that talking the anti-inflation talk would be sufficient to corral the inflationary forces it had unleashed, it was wrong. Inflation has been accelerating. This week, Chairman Powell indicated that, unless inflationary pressures moderate, the Fed will not wait until the second half of the year and will start raising interest rates in March. He continued to talk-the-talk by adding that the Fed may continue raising interest rates at each of its subsequent meetings; however, the Fed has not actually begun to walk that walk – there is no indication that the Fed considered raising rates or ending its bond-buying earlier, in February, instead of March. What the Fed wants to achieve is the taming of inflation without adversely affecting the economy or the stock market (a “soft landing”), an awesome feat if it could succeed! Powell repeated several times that “the economy this time is different” (a subject dear to TLR) and that the Fed will be both “nimble” and “humble” in executing its dual mandate of maintaining price stability and maximizing employment, thereby leaving open the possibility of no rate hikes this year … or five or more rate hikes … or raising rates by more than 25 bps on each occasion … or anything in between. Political pressure to fight inflation is dictating the Fed’s current priority and the Fed therefore will do its best to bring inflationary forces down … up to a point. This is a policy designed to fit today’s political realities. It will change prior to November, in time to enhance the Biden Administration’s chances in the midterm elections. It therefore may be prudent to prepare for the Fed to take extreme short-term measures that it reconsiders over the Summer.

If the Fed is unable to talk down inflation and escalates tightening actions, stock market prices will suffer. At an extreme, a restrictive, long-term anti-inflation Fed policy would lead to recession.

TINA has been relying on the “Fed put” – that is, assurances given and actions taken by successive Fed Chairs Greenspan, Bernanke, Yellen and Powell – to prevent adverse economic fallout from the Fed’s interest rate policies. Those actions have consistently propped up stock market prices.

But as Chairman Powell said this past week, this economic time is different. So are the inflationary headwinds and so too may be Fed actions. CPI has under-reported the real rate of inflation, which has risen for 19 consecutive months while understating the heavily-weighted Owner’s Equivalent Rent component – the rough equivalent of housing costs. OER was up “only” 3.8% in December, but with an intentional percentage-depressing lag effect. With actual rental costs and housing prices running close to 20%, the OER component of CPI will continue rising … and will do so at accelerating rates. Combine this embedded inflation rate with wage pressures, increasing energy costs, production shortages, deglobalization, and supply chain issues and the challenge the Fed faces in stemming inflation is daunting. Although supply chain issues are likely to abate as COVID recedes, wage pressures will not. Baby Boomer retirements have permanently taken a chunk of labor off the market. This means that Baby Boomers also no longer are putting massive amounts of money into their IRAs and, hence, into mutual funds. They are doing the opposite, withdrawing monies to support their retirement lifestyles. That will negatively impact stock prices. The stimulus checks that Americans invested in the stock market in 2020 and 2021 have been exhausted. Millennials and Gen Y-ers who relied on that capital to fund investment and trading profits in an ever-rising stock market may soon find it more challenging to earn their livings on Robinhood. With their stay-at-home incomes insufficient, they no longer will have the disposable capital to pile into equities (including meme stocks) and no longer will have excess cash to spend. That will depress economic growth. There also are lurking geopolitical and other risks that could trigger an economic calamity: a Russian invasion of Ukraine; a Chinese invasion of Taiwan; Iranian aggression against its neighbors; a hack of America’s electrical grid; an escalating oil and gas shortage; a climate calamity; a spreading recession in China; or an adverse COVID mutation. In short, there is no reason to be looking up for comets. Looking down is scary enough, and may be especially so for poor TINA.

Finally (from a good friend)