Elle Mundus/iStock via Getty Images
The stock market went up last week.
July 2022 saw the stock market’s best monthly performance since 2020.
The S&P 500 rose 9.1 percent in July, its biggest monthly gain since November 2020.
The NASDAQ rose 12.3 percent, its biggest monthly gain since April 2020.
Sonal Desai, chief investment officer for fixed income at Franklin Templeton, is quoted in the Financial Times as saying
“Financial markets only heard what they wanted to hear and ignored the rest.”
And what did some members of the investment community feel?
First of all, the economy is doing very well, thank you.
I caught that mood a couple of days ago while describing some of the economic numbers that analysts have been focusing on recently.
For example, industrial production figures were near historic highs. And capacity utilization is near recent highs.
In addition, the unemployment rate, at 3.6 percent, is the lowest it has been in decades.
You have to be a bit careful with this figure, as the labor force participation rate has fallen over the past two years to a near-term low.
But these numbers are very encouraging, even though the real GDP growth rate was negative for the second quarter in a row.
Second, earnings results from the business world have come in better than expected.
Third, long-term interest rates are expected to fall, even as the Federal Reserve is raising its short-term interest rate.
Market participants seem to be focusing on the upside here because the term structure of interest rates has reversed, and historically when that happens, it usually follows an economic downturn.
Finally, investors focused only on some of the statements of Jerome Powell, chairman of the Board of Governors of the Federal Reserve System.
The observations focused on the fact that Mr. Powell emphasized that he and the other Fed governors were watching the data closely, and if the data indicated that inflationary pressures were weakening, the Fed would certainly alter its policy.
And there you have it. A positive turn in the current economic situation.
The negative side
There are still plenty of negatives around…if one wanted to emphasize them.
On the one hand, inflation is still there, along with a lot of information that will continue at relatively high levels.
And inflation is not just a US problem. Inflation is a problem in Europe and elsewhere in the world.
In addition, there is still a lot of emphasis on the fact that the Fed will raise its policy interest rate several more times, producing further rate hikes at least through mid-2023.
In addition, the Fed has just begun to reduce the size of its securities portfolio.
The original plans for this effort indicated that the Fed envisioned this tapering effort continuing into 2024.
So earlier signs showed that Federal Reserve officials saw their current tightening stretching long into the future.
As Mr. Desai, in the end, the investment community only really hears what it wants to hear.
In the first half of this year, the stock market produced its worst first-half performance in more than 50 years.
The S&P 500 stock index fell 21 percent in the first half of 2022. And the NASDAQ fell 29 percent.
The volatility in the market was quite high.
Uncertainty was everywhere.
And it was only in March that the Fed started to raise its policy interest rate and it was only in June that the Fed actually started to reduce the size of its securities portfolio.
In other words, the Federal Reserve has just started tightening.
And the commercial banking system is flush with cash, a result of the excess liquidity the Fed injected into the system to combat the Covid-19 pandemic and the brief economic recession.
Still, many of the asset bubbles created by the Fed’s largesse in 2020 and 2021 are now receding, and we may still see some major corrections in these areas as bubble deflation continues.
And then there is the Russian invasion of Ukraine.
No one has any idea where this is going or what impact it will have on economies and financial markets around the world.
So the question goes back to the investment community.
Are you really focusing on the right things?
Personally, I don’t think you are.
I think the Federal Reserve still has work to do.
I still hope that Mr. Powell and the Federal Reserve follow their plan and do not retreat at the first cries of pain.
But by sticking to their plans, the investment community will see the stock market lower, falling below previous lows hit this year.
The American economy, as I’ve written about it, is still very dislocated. These imbalance conditions will need to be resolved, and given the state of these imbalance conditions, I believe there is substantial pain that will be experienced going forward.
Subsequent falls in the stock market are just one of the areas where this pain will be felt.