Don’t Fight the Fed, Round Two?

The Fed had its moment in Jackson Hole. While speculation grew that perhaps they would start to get a little softer with some signs of inflation easing, Chairman Jerome Powell went right at it, pinpointing inflation as enemy #1.  He went so far as to say the Fed isn’t afraid to inflict some economic pain to put the inflation demons to rest.  That rhetoric prompted stocks to fall on elevated odds of a recession.  Bond rates moved up as well, possibly indicating the belief the Fed is true to its word and inflation may stick around even a little longer than hoped.

Don’t Fight the Fed

If we back up and look at this, it all makes sense.  There has been the saying during the entire economic recovery since 2009 – “Don’t fight the Fed.”  This statement alluded to the idea the Fed was keeping rates low stimulating the economy, and because of this, don’t fight against the idea that both the economy and investment markets could continue to go up.  Now this saying may apply to inflation.  Inflation is the Fed’s number one target.  So, if bets are being made that inflation will spiral out of control, that’s a bet fighting against the Fed.

Even so, inflation is not going to go away quickly.  Look at the chart below.  Year-over-year inflation (as measured by CPI) peaked June of 2022 at 9.2%.  July’s reading eased a little.  However, if we look at what “normal” inflation is, the Fed’s target is about 2%.  Translate that into a monthly change, and inflation would be about 0.2% per month.  If “normal” monthly inflation started now, you can see the trendline of inflation for the months to come by the dotted line.

Source: BLS.gov

Inflation stays high for quite some time and doesn’t reach the approximate 2% level until mid-2023.  That’s assuming all goes smoothly.  It won’t go perfectly.  There are risks out there.  One is the Fed itself.  They already raised rates at a historically rapid pace, and those hikes take time for their effects to be felt.  However, the Fed is still going to raise rates even though we don’t know the effect yet.  Why?  Because they need to maintain as much credibility as possible.  If they back down now and inflationary pressures return, they lose more credibility, which already took a hit with their “transitory” language.  Less credibility lessens the impact of any future policy tool because markets will question the Fed’s resolve.  So, the Fed is going to keep hitting the brake even though the stop light ahead may be turning green.

Energy Is Not Helping

Another issue is energy.  We have our issues here in the U.S. with elevated costs.  However, it’s nothing like Europe.  Before Russia invaded Ukraine, natural gas in Europe was trading at about 72 Euros per megawatt hour.  On August 26, 2022, it was at a whopping 339 Euros.  Has the news gotten any better over there?  Not at all, the pipeline from Russia continues to be shut down, adding uncertainty while worries of a cold winter put millions of people at risk.  Yet from August 26^th through August 31^st, the price fell -30%.  It goes to remind us all just how unpredictable prices are.

Is it a Good Time to Invest?

Which gets to the point of whether now is a good time to invest or not.  Truthfully, it never feels like a good time to invest.  Either markets have gone up, and it feels like the opportunity has passed us by, or markets have been falling, making it feel too early or too risky to get in.  However, look at the chart below.  We hit a bear market earlier this year, so Goldman Sachs looked at what would happen if you got into an average bear market too soon.  In other words, what if you bought in and stock kept falling?  How much recovery time would this add to your portfolio?

Bear Markets and Recoveries

It turns out if you got in 5% before the bottom, two days were added to your recovery time.  If you got in 10% before the bottom, then ten days were added.  How about 15%?  Just 49 days!  If you’re investing for the long-term, a difference less than two months ends up quite small.

There’s so much pressure about getting in at the right time.  However, data backs up what we already know to be true.  Factually, markets are down or cheaper than they were months ago.  Add on top the belief over time that companies make money, causing markets to rise, leading to an opportunity for a deal – regardless of whatever negativity may lie ahead in the coming months.