The Fed, The Economy, and The Election
At the beginning of the fourth quarter investors were nervous about the economy. Late in September, billionaire investor Ray Dalio expressed that he was closely watching the “risky” U.S. fiscal situation. “We’re going to have a debt crisis in this country,” the founder of hedge fund Bridgewater Associates said in an interview. With the Fed continuing its restrictive interest rate policy, by the end of October, the S&P 500 index was down about 4%.
Markets are a discounting mechanism with a value based on the collective thoughts and actions of all investors. Every participating investor, whether they are sophisticated or merely a speculative newbie, will pay up or sell down to a price where they feel risk and reward are equal. The “market” considers all information available, and it is a moving target as to the degree of what weight is given to any one variable at any one point in time. Gyrations of the market are a direct reflection of changing investor sentiment about the balance of risk and reward.
At the quarter’s low, investors were keenly awaiting the U.S. Treasury Quarterly Refunding Announcement (QRA) which is a release of documents and data relating to Treasury borrowing and debt management policy each quarter. Due to high government spending to cushion against a recession, the amount of borrowing was expected to be high. The refunding was less than anticipated and the stock market took off.
During the Fourth quarter of 2023, the S&P 500 Index gained 11.2%, the NASDAQ index gained 13.6%, the Russell 2000 Growth Index gained 12.5%, and the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) gained 5.2%.[1]
It was a relief for many to see the stock market turn up, but many personal and institutional investors were caught by surprise and jumped in to catch up. Many times, this is the way to underperform since a traditional risk and reward view can be temporarily thrown out the window.
In 2024 investors will have their hands full. We have to navigate changes in the following:
- The strength of the economy. At crucial times, the Fed has been providing stimulus to avert a recession.
- The four-year election cycle.
- Movements by the Federal Reserve (Fed). It performs five general functions to promote the effective operation of the U.S. economy and, more generally, the public interest.
As a reminder, the Federal Reserve:
- conducts the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy;
- promotes the stability of the financial system and seeks to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad.
- promotes the safety and soundness of individual financial institutions and monitors their impact on the financial system as a whole;
- fosters payment and settlement system safety and efficiency through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments; and
- promotes consumer protection and community development through consumer-focused supervision and examination, research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.
As everyone knows, there are two sides to a story and in financial markets and politics, this is especially true. Since the future is not known, a believable story using facts generated by data-mining historic information can be made.
In my view, the recession that I anticipated last year will occur this year. It is impossible to determine the severity because there are many unknown factors, such as the timing, the root cause, and the responses of the Fed, businesses, and consumers. The Fed tries to avoid controversy in an election year, as it has done before, and will only change its policies if the economy worsens significantly.
This implies that the stock market, barring a black-swan type event, will fluctuate upward without a major gain.
Jamie Dimon, the CEO of JP Morgan Chase, made some remarks at Davos, a global financial conference, that resonated with me. I would like to share his views with you.
Mr. Dimon said:
- He thinks it is a mistake to assume everything is “hunky dory” with the economy.
- He is more cautious than most people on 2024 and 2025.
- If a country does not control their borders, it will be “destroyed”.
- Notes geopolitical risks in 2024 and 2025.
- US large debt load will “come back to bite us” in the next 3-5 years.
- Deficits are inflationary and it has a cumulative effect on younger people.
- This is the last time he wants to talk about bitcoin: Bitcoin is a “pet rock” it does nothing. It is used for fraud and sex trafficking.
- Commercial real estate will be a “small problem” with a soft landing, bigger problem with a harder landing.
As you can see, large investors look at the large picture and do not concentrate solely on the present. Many investors get hurt by concentrating on the immediate future and do not have the expertise to see the big picture. I look at how the big picture is developing and attempt to identify already successful companies which may prosper even more in the future.
This discipline can take some time and investors need to be comfortable with returns that may not follow the market.
Positives:
- Consumer sentiment as of January 19th, rose to its highest level in 2-1/2 years.
- The recent futures contracts interest rate trend indicates a lower probability of sooner than later interest rate cuts by the Fed implying a more than expected resilient economy.
- Money Market Fund Assets as of January 18th of $5.96 trillion is at historic levels and provide a backdrop of new assets which could enter or buoy the stock market.
Negatives:
- Possible government shut down following the third stopgap funding bill, known as a “continuing resolution” or “CR,” causes financial market unrest.
- The U.S. equity market’s rally at the end of 2023 has left stocks overvalued, with little room for error.
- The Fed waits too long before easing interest rates which may cause a larger economic slowdown than expected.
- Geopolitical unrest escalates.
As we know, the markets have priced in aggressive interest rate cuts by the Fed and that there will be a soft landing from their fight against inflation. In the quarter, other than searching for attractive investment ideas, I will be watching the Fed moves closely and respond as needed. I expect them to project cutting rates slower than investors expect which may cause the market to drop and provide an opportunity.
Very truly yours,
Martin L. Yokosawa
Torii® Asset Management, Inc. Landolt Securities, Inc.
9S040 Stearman Drive, Naperville, IL. 60564
Copyright Martin L. Yokosawa. All Rights Reserved
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Torii Asset Management, Inc. and Landolt Securities, Inc. are not affiliated companies.
[1] These returns are price based and exclusive of dividend reinvestment. Return data provided by QUODD Financial, ETFreplay.com, and Yahoo Finance