Catching Lightning in a Bottle
The idiom catch lightning in a bottle means to accomplish a nearly impossible task, to trap something elusive or fleeting. The origins of the phrase have not been verified but it is often credited to Benjamin Franklin’s experiment where he flew a kite during a thunderstorm in hopes of lightning striking the kite, traveling down the string and being collected in a Leyden bottle. (Fortunately the experiment was a failure, otherwise one of our country’s Founding Fathers could have been electrocuted.) The Federal Reserve is faced with a nearly impossible task right now, engineering a “soft landing” for the economy.
We are dealing with historically high levels of inflation now due to supply chain constraints and higher demand for goods and services resulting from stimulus payments and easy monetary policy. While the latter two were most likely necessary to keep our economy from ruin during the early days of the pandemic, looking back it can be argued that we, or more precisely our government officials, went too far. In hindsight, there is little argument that the Federal Reserve was too loose with monetary policy and should have began tightening much sooner instead of insisting that inflation was “transitory.” Now the Fed is faced with difficult decisions, the implications of which might be the largest in a generation, if not longer. If they do not tighten the money supply enough, through interest rate hikes and bond buying, a.k.a. quantitative tightening (“QT”), inflation is likely to get worse and we will be faced with even larger problems. If they tighten too much, especially by raising interest rates too quickly, the risk is it will slow growth considerably and cause irreparable harm to the economy. Hence, the goal of doing enough but too much so there is a “soft landing,” such as what one hopes for when flying in an airplane. With the size of the economy being about $25 trillion dollars, this certainly is no easy task.
As expected, the Fed did raise interest rates by one-half of one percent, often quoted as 50 basis points, last week. This was the largest increase since the year 2000. After the meeting, Fed Chairman Jerome Powell stated that a three-quarter point, or 75 basis point, hike was not likely at the next meeting, but it remains widely anticipated we will see half-point increases for at least the next two Fed meetings. The Fed Funds rate is now at 1% while inflation remains near 8%. There is no magical formula that says the Fed Funds needs to match the inflation rate, however conventional knowledge says that interest rates have a lot of room to move higher before they have the desired impact on bringing down inflation. Interest rate hikes generally take months to work through the system and have a noticeable effect, so the Fed also must be concerned about not “overshooting” and raising rates too much or too fast.
As an 80-1 longshot, Rich Strike won the Kentucky Derby over the weekend. Given the odds, the name seems fitting and might even conjure up an image of a lightning strike. There were some storm clouds over the stock market last week, where we experienced wild swings, especially on Wednesday after the Fed meeting with the market being significantly higher, and then again on Thursday where the markets suffered their worst losses in over two years. Despite the day-to-day roller-coaster ride including some signs of panic, the S&P 500 and Dow “only” lost 0.2% for the week while the tech sell-off continued with the Nasdaq dropping 1.5% for the week. It may seem incredulous, and is certainly unprecedented, but bond yields continue to move higher, causing continued pain in the bond market. This is the worst year-to-date start for the Bloomberg Barclays US Bond Aggregate Index since its inception in 1977. Even in 1994 when the Fed raised rates six times for a total of 2.5%, the index only lost 3% compared to the 10% losses experienced so far this year.
Last week the monthly employment report showed continued growth in the labor market and unemployment remaining steady at 3.5%, a relatively low number. The reported increase in hourly earnings was slightly less than expected, leading to some postulation that labor costs are perhaps slowing which could ease some of the inflationary pressure since this is a major expense for most businesses. Job openings remain at historically high levels, but the labor force participation rate decreased signifying there are fewer people in the workforce. Overall the labor market remains strong and is not showing signs of cracking, despite reports of a slowdown in economic growth. In the eyes of the Fed this is good news because they have the dual mandate of price stability and maximum employment so they can maintain their focus on the former for the time being, but this also indicates they can continue to raise rates for the foreseeable future since the labor market does not yet seem to be affected.
The monthly Consumer Price Index (CPI) and Producer Price Index (PPI) reports will be released this coming week. As inflation remains a central theme, not only in the markets but also in everyday life, there will be a lot of attention on both. Projections are these reports will show that inflation has slowed from last month but they are both fully expected to reflect a continuation of rising prices. Even if inflation does start to slow it is likely to take many months, if not years, to return to long-term “normal” levels and the large price increases already experienced will not be reversed.
The continued volatility in the market is a good reminder of the importance of having a solid plan in place and maintaining a long-term outlook. When it comes to buying stocks, it should not be short-term speculation, but rather investing in companies that will provide shareholder value over the next several years. It is nearly impossible to catch lightning in a bottle; don’t leave your retirement up to a long-odds chance, let us help you craft a solid plan to weather all storms.
Have a great week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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