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Same Downward Drift

  • Investing
  • 3 min read

Markets ended the year with more of the same downward drift.

The Federal Reserve continues its hardline against inflation (which it is responsible for creating). How long they continue on this path is more related to politics than economics. When politicians begin to scream, the Fed is likely to back off on interest rate increases.

If the Fed were serious about cleaning up the economy, it would begin QT (quantitative tightening), a process that would reduce the money supply and clean up the Fed’s strained balance sheet. QE (quantitative easing) caused the upward explosion in prices (and artificial economic activity)! That needs to be reversed (both for Fed solvency and a return to a normal economic environment). It is unlikely that will happen because it would reveal the two-plus decade failure of economic and monetary policy.

There is likely no reasonable way out of the current economic condition without a major disaster. The misallocation of resources is enormous, building up over decades (but especially since the turn of this new century). The economy needs an enema, but no politician is willing to allow proper treatment. Thus, we will drift further into mediocrity until some event triggers a disaster.

The Federal Reserve continues to talk a good game against inflation (which it created). Thus far, it shows little sign of backing away from this stance. Perhaps another 1,000 or more points in the Dow will force it to change its mind. Political pressure is already being brought to bear to ease off.

Interest rates are not the problem (although they are a convenient whipping boy)! The problem is decades of monetary-induced growth which has produced an economy that cannot withstand a slow-down or a correction. Distortions in capital allocation have occurred and this capital needs to be liquidated and re-allocated to more proper uses. This process produces a recession or a depression. Real economists see the process as necessary in order to produce real and productive growth again.

In the meantime, drops in market valuations continue. The scorecard for the four asset classes tracked from July 26 to Friday’s close is as follows:

There is little surprise in this data. Interest sensitive investments are getting hurt badly as are the previously over-priced tech investments. Blue-chip companies have held up better than anticipated and Gold has moved up slower than anticipated. My guess is that blue chips have benefited as a “parking spot” for some of the capital withdrawn from tech and that is unlikely to continue for much longer. Gold, while outperforming the other categories, has underperformed my expectations thus far. I expect it to become a safe-have asset once things really get tough.

For younger investors, the beginning of a new year is likely seen as a bright spot. In my opinion, it is not. The corrective process underway has barely begun. I suspect there is a lot more downside to stocks.

Stay cautious!

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