The Inflation of the 1980s Tells the Same Story: Pivot=Decline
I have heard both sides: 1) Historically, the Fed pivot will result in a decline in equities because they are pivoting in response to negative economic data which drags on equities, and 2) this time is different, negative economic data is positive for equites because it means inflation is on its way down.
When people reference the former, for whatever reason, they don't take a look at the effective Fed Funds Rate in the high inflationary period of the late 1970's and early 80's and compare the Fed's pivot to equities. In the chart shown, you can see that once Volcker, the Chairman of the Fed, finally took a steadfast position against inflation and rose rates violently, inflation began to cool. Both in part of this raise in rates and the public's belief that Volcker had no intention of letting up, ridding the public of inflationary expectations.
If you look at the charts, you can see that as inflation rose so did the markets. But as Volcker stamped his foot and pushed rates up, inflation began to cool. USIRRY, the third chart down, shows this. Equities began to decline due to this restrictive economic environment and belief the Volcker would not let up.
Notice that, as a result, unemployment (bottom chart) began to rise. This had no positive impact on equities, contrary to what some might think because it would indicate inflation was being taken care of. Instead, the U.S. entered a recession and equities continued to decline. It was only once the Fed stopped lowering rates, unemployment peaked, and inflation neared their target rate did equities bottom.
It is not fair to compare equities and pivots to the Great Recession or the .com Bubble, yet even in historical inflationary periods the same story plays out: the markets bottom well after the Fed pivots
However, this time could be different in that Powell showed no hesitation in attacking inflation and destroying inflationary expectations. He has taken a direct lesson from history. As a result, unemployment could potentially peak faster than expected, inflation could decrease faster than expected, and equities could bottom faster than expected. I believe today's outcome will be similar to that of the early 80's, but that outcome will happen much, much faster. The markets have not bottomed in my opinion, but I expect them to in mid-late 2023.
It's always best to keep equity exposure to avoid missing the bottom.
Because you never know.
InTheMoney
When people reference the former, for whatever reason, they don't take a look at the effective Fed Funds Rate in the high inflationary period of the late 1970's and early 80's and compare the Fed's pivot to equities. In the chart shown, you can see that once Volcker, the Chairman of the Fed, finally took a steadfast position against inflation and rose rates violently, inflation began to cool. Both in part of this raise in rates and the public's belief that Volcker had no intention of letting up, ridding the public of inflationary expectations.
If you look at the charts, you can see that as inflation rose so did the markets. But as Volcker stamped his foot and pushed rates up, inflation began to cool. USIRRY, the third chart down, shows this. Equities began to decline due to this restrictive economic environment and belief the Volcker would not let up.
Notice that, as a result, unemployment (bottom chart) began to rise. This had no positive impact on equities, contrary to what some might think because it would indicate inflation was being taken care of. Instead, the U.S. entered a recession and equities continued to decline. It was only once the Fed stopped lowering rates, unemployment peaked, and inflation neared their target rate did equities bottom.
It is not fair to compare equities and pivots to the Great Recession or the .com Bubble, yet even in historical inflationary periods the same story plays out: the markets bottom well after the Fed pivots
However, this time could be different in that Powell showed no hesitation in attacking inflation and destroying inflationary expectations. He has taken a direct lesson from history. As a result, unemployment could potentially peak faster than expected, inflation could decrease faster than expected, and equities could bottom faster than expected. I believe today's outcome will be similar to that of the early 80's, but that outcome will happen much, much faster. The markets have not bottomed in my opinion, but I expect them to in mid-late 2023.
It's always best to keep equity exposure to avoid missing the bottom.
Because you never know.
InTheMoney
Comment:
Top of the 3 charts is Fed Funds Rate, 2nd one is inflation metric, 3rd is unemployment rate.
Comment:
I would like to add that a significant difference in today's climate is that a lot of selling has come BEFORE the pivot. Historically, this has not been the case, and I'm not entirely sure what to make of that at the moment.
Comment:
I think in response to the above, it doesn't mean much. As far as % moves go, the .com Bubble caused SPY to experience the same 15-16% decrease in valuation BEFORE the Fed pivot.
If the Fed plays their cards right, I think it is possible to recover to some level of overall stability by the beginning of 2024.
If the Fed plays their cards right, I think it is possible to recover to some level of overall stability by the beginning of 2024.
Comment:
And looking at QQQ, which is more applicable to the .com Bubble, it fell 40% before the Fed pivot, then fell another 70% after the pivot. So I think after complete analysis, I stick with my initial thesis.
Comment:
I think it's important to follow up this idea with the fact that this is a longer-term bearish thesis. There is potential for a strong market rally if CPI comes in under 7.7 tomorrow (12/13/22) as it implies a 50bp rate hike this month is confirmed. This thesis revolves around when unemployment ultimately rises as a result of rate hikes (and then a resulting pivot), as economic impacts lag monetary policy. Do not assume this thesis means SPY tanks tomorrow by any means, do not assume I am implying you all-in puts or some dumb shit. If you bought right now, you're already taking a good discount. But if you wanna hedge by holding some cash to POTENTIALLY buy a bigger dip next year, then that's an option.
