Call it the Great Uncertainty.
With the stock market recovering from its lows, investors should now be feeling pretty good. They survived a bear market. They survived the fastest rate of rate hikes in decades. They even survived what could have been a recession. And yet it only took one bad week – the
first drop after four weeks of gains – to let the doubt creep back in.
As it should. For the past 40 years, markets have had fairly recognizable rules. Dips were there to buy. And the Federal Reserve has always been behind the market. Sure, the Fed could raise interest rates if inflation gets too high — even trigger a recession — but it would always cut again after doing what it had to do.
And if things got really bad, the Fed would do anything to stabilize the financial system and get stocks to resume their steady upward trajectory after a fall. No wonder buying and holding index funds has been the best way to invest for decades.
The latest inflation fear has changed all that. Inflation makes people feel like they can barely keep up, even when they get pay increases. It makes strong economic growth feel like stagnation, and it creates a world of mixed messages that are hard to decipher as bullish or bearish.
Sometimes it has caused mass confusion. Is the labor market strong? A recent study by PricewaterhouseCoopers doesn’t shed much light. It found that 38% of respondents said hiring the right talent was a big risk just behind cybersecurity, while 50% said they were reducing staff numbers. Nor are speeches from Fed presidents, some of whom see more three-quarters point rate hikes in the future, while others argue that the central bank should be more cautious.
Even reading the minutes of the latest Federal Open Market Committee meeting, published last week, seemed more like a Rorschach test of our personal biases than anything that could provide direction. “The July FOMC minutes show the Fed is trying to calibrate how restrictive policy should be, but didn’t give a clear signal for September,” JP Morgan economist Nora Szentivanyi wrote.
Optimists will, of course, point to the fact that with lower oil, gasoline and food prices, inflation is about to slow down. But it’s still unclear where it will level off — or whether the Fed will push for the core personal consumption spending index to return to 2%. Either way, it’s impossible even for the Fed to know if it’s done enough, and it will have to make the mistake of fighting inflation until the battle is won.
If so, the “Fed pit” is really dead. For as long as most investors can remember, they could count on the central bank to bail them out if the market fell too far or things got too rock solid. Now, the opposite may be true, if a rising market keeps financial conditions too loose to keep inflation in check. It’s one of the reasons it’s so concerning to see the return of meme-stock mania, if only for a week or two. When financial conditions are tight, stocks like:
Bed Bath & More
(ticker: BBBY) must not rise 400%.
None of this means that markets should tumble, but it does mean that investors shouldn’t rely on what has worked to keep working. Oil stocks were hot, until they weren’t anymore. Technology was waste until everyone wanted to buy it again. Even momentum stocks — the ones that have performed the best over the past year and are expected to continue to gain — have failed. The
iShares Edge MSCI VS Momentum Factor
exchange-traded fund (MTUM) is down 19% in 2022, worse than the 11% drop in the S&P 500.
It’s a tricky situation. It’s a market with big drops, but also with big cracks, one that forces investors to accept low returns from index funds or try a more tactical approach, says Stifel’s Barry Bannister. He is particularly concerned that the Fed will invert the three-month/10-year yield curve as early as September, predicting a recession in 2023, but he also notes that stocks have usually risen in recessions.
That’s just one more contradiction that investors will have to grapple with as they make their way into 2022.
Write to Ben Levisohn at [email protected]