Hello: February 1, 2022

This past year was a great year for stocks but not particularly good for bonds. I have always invested the majority of assets in US stocks. My thought was emerging market (EM) stocks do not have safeguards in place from an accounting perspective and China is the 800-pound gorilla which many EM companies rely on. The European markets have their own issues regarding debt, socialism, and a reliance on Russia for their energy.

The US stock market has been steadily climbing since March 2009. The US should have experienced one if not two recessions during that time period. Recessions are caused by stock market drops or vice versa. A black swan event can cause stocks to get cut in half. Through history about 50% of the time stock bear markets are caused by exogenous shocks to the system. Such a shock occurred in March of 2020. The stock market lost 30% from Feb. 21 and bottomed March 21st. The stock market was again saved by the US Federal Reserve which suppressed interest rates and flooded the US with cheap money which saved the US from a depression and has led to the current inflation, again saving the stock market in the process.

The Fed’s two main tools have been:

1. To lower interest rates which leads to risk taking.
2. To buy ALL varieties of bonds, which leads to lower bond rates, especially mortgage bond rates which leads to more home buying.

This has been referred to as interest rate suppression and increasing the balance sheet of the Fed which was at $1 trillion in 2008 and doubled in 2009, saving the stock market. Currently the balance sheet is near $9 trillion which is about ½ of the US GDP!!

If you look, almost every asset class is at or near all-time highs. Art, wine, gold, oil, commodities, stocks, bonds, crypto all are inflated due to the easy money policy of the US Federal Reserve. Playing musical chairs is fun until the music stops and there are not enough chairs.

The Fed announced they will be reducing the balance sheet and will be raising short-term rates. The question is how far they will be able to “normalize the balance sheet and rates” and what will be the consequences. If they move to fast, we have a recession. If they move too slowly, then inflation will persist. If the rate of normalization is just right, we will have a growing economy.

To recap, the US Federal Reserve has saved the economy several times over the last 15 years by using extraordinary measures. Have they painted themselves into a corner or will they be able to exit without consequences? Call me a realist but they can only postpone economic pain. Recessions are normal and are necessary for economic cleansing.

Regards,

Derrick Handwerk.