Powell: Trend change is coming

[WendyBG]

https://www.federalreserve.gov/newsevents/speech/powell20220…

**August 26, 2022**
**Monetary Policy and Price Stability**

**by Chair Jerome H. Powell**

**....**
**Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy. Committee participants' most recent individual projections from the June SEP showed the median federal funds rate running slightly below 4 percent through the end of 2023. Participants will update their projections at the September meeting....**

**That brings me to the third lesson, which is that we must keep at it until the job is done. History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting. The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.**

**These lessons are guiding us as we use our tools to bring inflation down. We are taking forceful and rapid steps to moderate demand so that it comes into better alignment with supply, and to keep inflation expectations anchored. We will keep at it until we are confident the job is done....**

Powell clearly says that the Fed will keep the fed funds rate above the “neutral” rate. Powell said, “At our most recent meeting in July, the FOMC raised the target range for the federal funds rate to 2.25 to 2.5 percent, which is in the Summary of Economic Projection’s (SEP) range of estimates of where the federal funds rate is projected to settle in the longer run.” This shows that the Fed does not plan to return to the zero fed funds rate that shoveled immense, unprecedented amounts of fiat money at negative real yields into the asset markets for most of the time since 2008.

https://fred.stlouisfed.org/series/FEDFUNDS
https://fred.stlouisfed.org/series/WALCL

If the Fed actually follows through on this strategy, it’s a generational trend change. Asset prices have been settled with the assumption that negative rate lending and the Fed “put” (where the Federal Reserve immediately cuts the fed funds rate whenever the stock market drops) will continue indefinitely into the future.

A Fed study showed that 10% of listed companies are “zombies” which can barely make the interest payments on their debts but don’t have enough cash flow to pay them off. The debts must be rolled over (refinanced) when they mature. If interest rates rise for the long term, many of these companies may default.

Only the unprecedented flood of money has enabled the unprecedented rise in all asset prices – stocks, bonds and real estate. I don’t expect the Fed to withdraw this money (e.g. by selling its huge book of Treasury and mortgage bonds quickly) but it takes continuous pumping to achieve continuous growth.

The sudden rise in mortgage rates over the past 6 months shows what happens without continuous pumping. They have returned to almost the same rate as the pre-2008 rate.

https://fred.stlouisfed.org/series/MORTGAGE30US

IF the Fed has actually changed strategy – IF they intend to return to an economically neutral role, fulfilling their mandates* but not pumping the asset markets, it is the biggest trend change since the 2008 financial crisis.

That’s a big IF. The near-term trend change will be a drop in the asset markets with temporarily higher rates. The longer-term rates (and stock valuations) won’t change much unless the market is convinced that the Fed has truly changed its fundamental mode from stimulative to neutral. But IF the Fed does go from stimulative to neutral in the long term – watch out. Asset valuations will eventually return to the historic average if they do.

https://www.multpl.com/shiller-pe

Wendy
*The Fed’s dual mandate is price stability and maximizing employment to the point that wage inflation doesn’t result.

[bjurasz]

I keep thinking you are going to be wrong about this, but I don’t think you are. Watch out below.

[Leap1]

Expect all boats to drop, equities, bonds, commodities and cryptos.

Since the Chinese are working more internally on their economy the impact might be minimized at least.

The swaps market in the west though faces a possible challenge as factories stay shutdown or capacity utilization in China and a build out has to keep happening in the west. This is less a function of Chinese corporate profits and more a function of western corporate profits. Making the current surge in profits very useful for the entirety of western markets.

Fiscal tools matter to our future.

[38Packard]

Watch out below.

And I guess I’d add that … and don’t be in too much of a hurry to dive back in.

I have read on more than one thread here that downtrends can last months / years. I don’t have the time to give the specific links to graph examples, I will share that based on my experience, I’m not going to be in a huge hurry to jump back in.

I also think there is a nice indicator called the 99MungoRule that when flips, it’s pretty safe to jump back in.

We all have our individual risk profile and financial management styles, I’m more conservative than most, I’m sure.

Best,
'38Packard

[desertdaveataol]

I also think there is a nice indicator called the 99MungoRule that when flips, it’s pretty safe to jump back in.

If you, like me, don’t know the 99MungoRule Here’s a link:

https://discussion.fool.com/mungofitchs-99-day-rule-30082893.asp…

You’re welcome.

[CMFJambo]

So does the 99 day rule work with making new lows? We have until September 20-something.

For me I’m watching the long bond market and the US$ that have not been confirming what equities have been saying (peak inflation is past). Until yesterday when Jerome said even if peak inflation is past we are like Smokey the Bear and we will continue to pour water and shovel dirt on the embers.

Now if we can hold SPX 4000 or so and turn up again, AND US$ confirms the top was DXY 109.3 earlier in August AND long bonds start catching a bid (TLT $120+), then my cash and hedge plays are back in my longer term growth picks.

Joe
Community Fool

[captainccs]

I will share that based on my experience, I’m not going to be in a huge hurry to jump back in.

I never jumped out! Not only is it impossible to time the market, it’s double impossible to know when a bureaucrat will say something that roils the market. Instead have a strategy to profit from the volatility.

Stock rises, sell covered call
Stock falls, buy it back
Rinse. Repeat.

These days most of my option trades are GTC at ‘my target’ price. If it executes, great. If not, it was not worth executing.

Trying to invest as if one could tell the near future is futile. One can have long term expectations like “Climate alarmists will prevail, buy wind, solar, & EVs.” Which to buy? Best of breed. Doing nothing is one of the hardest things to do but also the most profitable long term. And you save on fees, commissions, and taxes.

So why sell options? Because they are the best tool to profit from volatility, they amplify the underlying’s volatility. The best analogy to selling option is the gambling casino where the seller is the house that sets the vigorish and the buyer is the gambler who hopes the stock will rise (calls) or fall (puts) sufficiently before expiration. The buyer cannot foretell the future!

The house knows the vigorish. The simplest example is roulette which has 72 numbered slots and an additional one or two slots, zero and double zero. Bet on a number or on the zeros and if you win you are paid 72:1. But the odds of winning are less than 1 in 72. By the law of large numbers in the long run the house makes money – the same principle that actuaries use to set insurance rates. How much? 1/73 or 2/74, i.e. 1.37% or 2.70% of the sum of the bets. The only way the casino can lose is by allowing very large bets which is the reason for the limits. Each game has a calculable vigorish. The only game I know of where players can turn the vigorish legally in their favor is blackjack by counting the cards which is the reason ‘counters’ are not allowed to play.

The above arithmetic applies to selling covered calls with one caveat, don’t play with stocks that will go bankrupt. The best are volatile flatliners. Because you set the prices at which you are willing to trade, you are in control.

Trend change is coming

Volatility is here to stay! On August 18/19 I made the best and fastest round trip I ever made

Aug 18, sell covered call for $9.50
Aug 19, buy back covered call for $5.60
Expiration was 28 days away. Made 41% of the max profit overnight

To death and taxes add bureaucrats! The difference is that you can profit from their ‘pronouncements from on high’ by gaming the volatility they create.

The Captain

[captainccs]

Aug 18, sell covered call for $9.50
Aug 19, buy back covered call for $5.60
Expiration was 28 days away. Made 41% of the max profit overnight

PS. Five days later I sold more covered calls on the same stock again at $9.50 30 days out!

Crazy volatility is your friend!

The Captain

[eweppl]

Gaming this out a bit…

We often read about the potential for huge numbers of Americans being short of retirement funds. Now, I would. hypothesize that on a financial forum like this - that is not high on people’s list of problems but general public - IT IS.

Now add in the specter of trend change…where juicing the hallowed S&P 500 isn’t the Fed mission.

What of people WITH enough, or close to enough retirement funds?

My point…

Many of them will have used some sort of historical return on investment number. Many pension funds may have used a return on investment number based somewhat on history.

Now- if you whack that ROI by 1 or 2 or 3%…and couple in an aging population of retirees - what are economic ramifications?

Also, less capital gains tax revenues – some states reap those windfalls when returns are good.

[AlphaWolf]

The house knows the vigorish. The simplest example is roulette which has 72 numbered slots and an additional one or two slots, zero and double zero. Bet on a number or on the zeros and if you win you are paid 72:1. But the odds of winning are less than 1 in 72.

Captain,

Your thought process is accurate, but I do have a technical correction.

Roulette wheels have 36 numbers plus either one zero (Europe) or two zeroes (U.S.). So there are 37 or 38 slots, but the payout for a single slot is 35 to 1. Over the long run, it is impossible to win.

I have read several books on winning strategies in roulette. Some are better than others, but they all lose in the end because of this thing called math.

I once saw a guy in a Vegas casino play a stack of chips on 7, which came up 3 times in a row. The day after I checked the newspapers for a story about bodies found in a dumpster. Didn’t see anything.

AW

[WendyBG]

<Aug 18, sell covered call for $9.50
Aug 19, buy back covered call for $5.60
Expiration was 28 days away. Made 41% of the max profit overnight>

Captain, I applaud you! Brilliant!

Wendy

[captainccs]

Your thought process is accurate, but I do have a technical correction.

Roulette wheels have 36 numbers plus either one zero (Europe) or two zeroes (U.S.). So there are 37 or 38 slots, but the payout for a single slot is 35 to 1. Over the long run, it is impossible to win.

Thanks. My memory ain’t what it used to be, I don’t remember what I forgot! LOL

The Captain

[WendyBG]

<What of people WITH enough, or close to enough retirement funds?

My point…

Many of them will have used some sort of historical return on investment number. Many pension funds may have used a return on investment number based somewhat on history.

Now- if you whack that ROI by 1 or 2 or 3%…and couple in an aging population of retirees - what are economic ramifications?>

Eweppl, this is a serious concern.

Pension funds often use growth numbers that are well above the current risk-free market return. When I read these future expectations I shake my head. They are gambling on long-term growth rates based on expectations that aren’t realistic in a low-return environment. Just at the time that they will need large distributions due to retirement of baby boomers.

The high returns were juiced by the Federal Reserve by keeping interest rates low since at least 2008 (a case can be made for “since 2001.”) If the Fed decides to keep the fed funds rate neutral and set the market free of manipulation, the whole equilibrium will change.

All asset prices will fall and will eventually stabilize at the new, lower level which hasn’t been seen in decades. Bond prices that were meant to be “low risk” and stabilize stock volatility will also fall, since bond prices fall when interest rates rise.

This is also true of individual investors. Let’s say the investor holds a standard 60% stock/ 40% bond portfolio. The average investor is told to buy bond funds since they are “professionally managed.” The NAV of a bond fund will drop as interest rates rise. The original NAV will not be seen until the duration of the fund, which could be many years. This is why I don’t invest in bond funds, but rather in a ladder of CDs and bonds which I hold to maturity. (I-Bonds always return full principal if they are held for a year or more, regardless of interest rates – they are the only bonds that do.)

Most METARs are more interested in stock investing, but $trillions in bonds are held by investors of all kinds, from individuals to pension funds to foreign countries. All of these will lose value if interest rates stay higher than the previous depressed rate. The longer-term the bond, the more value it loses.

This is a big problem. You have put your finger on it. Some pension funds will run out of money to distribute. Same for individual retirees.

Wendy

[AlphaWolf]

Thanks. My memory ain’t what it used to be, I don’t remember what I forgot! LOL

I get my exercise going up and down the stairs 3 times.

I forget why I went up the stairs the first 2 times.

AW

[desertdaveataol]

Thank you for recommending this post to our Best of feature.

I will share that based on my experience, I’m not going to be in a huge hurry to jump back in.

I never jumped out! Not only is it impossible to time the market, it’s double impossible to know when a bureaucrat will say something that roils the market.

I don’t ‘jump’ in and out of the stock market either, better to sit back and enjoy the dividends.

2022’s Dividend Aristocrats List: All 65 Stocks
These dividend aristocrats have upped their payments annually for decades.
(Scroll down for list)

https://money.usnews.com/investing/stock-market-news/article…

Desert (CVX, XOM, T, BNS, BKH, ED, ATGFF, NI, NWN, TRP, ENB, WRE, WGL, XEL, DUK, SO & KO, WTR, O) Dave