It is easy to make things too complex in investing and trading. It might seem dangerous to oversimplify when it comes to money, but generally it’s much safer to keep things simple that get convoluted.
There is never a better time to keep it simple than during a crash like we are having.
This is my simple model:
1) Covid, followed by
2) Huge monetary actions by government to stave off a collapse
3) More money, less stuff made, prices go up
The mechanism for all this is the central banks of the world and they don’t come bigger or more active the Federal Reserve.
Without the Federal Reserve’s printathon we would all be very far up shirt creek without a paddle. Better a burst of high inflation than the 1930s all over again.
But let’s forget whether what has happened is for better or worse, here we are with a crash on deck and it’s because the Federal Reserve has stopped bailing everyone out.
Here is the chart of that process and its halt, care of the Fed:
Let’s just say since Covid, the Federal Reserve doubled its balance sheet, which means in simple terms they pumped giant amounts of new money into the global economy in return for the promises (debt instruments) of others.
This is what happened to the stock market:
You will note that it, too has roughly doubled in the same period. When new money is printed the outcome can go two ways, into assets of the rich where it trickles down with little inflation or into the spending of everyone else where it tears up prices. The Covid “stimmies” went in at street level and hey presto, we have inflation.
When you overlay the result of the Federal Reserves’ QE you see this:
A disrupted world can only stay afloat with constant “inflation” as every country in trouble has found for thousands of years. As soon as the tap is turned off, down goes asset prices well in advance of the action, because markets look past now and into the future when today’s and tomorrow’s action have an impact over months and years.
The good news is, the market sees ahead so it is pricing in the state of affairs in summer 2023 so it is running ahead of the outcome of Federal Reserve tightening so it has already baked in cutting back nearly half of the Federal Reserve’s Covid QE. The S&P 500 is worth about $10 billion a point, so you can say that $10 trillion-plus worth of wealth has been eliminated since the high so that in itself will drag heavily on money supply. The apparent multiplier of 5 times, the market gets in market cap for every dollar of newly printed money, the Fed has already deflated the U.S. economy by 40% of what it pumped in to support the economy during the Covid crisis.
What happens next is down to the central banks of the world and they are going to be balancing huge fiscal deficits on one hand and inflation on the other. It’s going to be a juggling act with elevated inflation, low interest rates (by old fashioned standards) and volatile markets. It’s going to be risky and stressful.
To get to the other side of the Covid financial crisis, inflation will be untameable for quite a time, no one can afford the collapse of asset prices and the tax base that goes along with it, if central banks were in a hurry to drive out inflation at any cost. As such, the downside for the market is steep but also limited.
The solution to inflation according to “new monetary theory” is to simply tax the excess money away. That however is as politically likely as catching politicians telling the truth. The sneaky way is to let inflation do its thing having stopped printing new money and watch inflation grind to a halt as no new money drives its vicious circle.
Is there an escape hatch? The only thing looking half decent is the Swiss Franc. Beyond that we are down to stock picking and hoping the Fed has a plan.
I think the Fed does, so it’s worth staying in stocks but probably not the amazing tech companies that up to now have done so well for so many.
3,500 is my guess, but that will be purely down to avoiding a rout. It’s going to be close!