Two newsletters ago, I ended the column with “Zoom out. Think longer.” And wow, did none of y’all listen. By y’all I mean “all y’all,” the persistent Mr. Market that reacts violently to new news, old news and no news. Sometimes good news is even bad news.
The market does weird things, and so this week I wanted to zoom in on the market’s initial reaction during and subsequent retracement following Fed Chairman Jerome Powell’s FOMC press conference on May 4. This week’s newsletter will be chart heavy, but the charts are necessary to tell the story I want to tell about today’s markets and Mr. Market.
That (and maybe more …) below.
– George Kaloudis
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Eight times a year, the Federal Open Market Committee (FOMC) meets. The FOMC is part of the Federal Reserve System (the “central bank” or the Fed) in the U.S. and is made up of 12 presidents from various Reserve Banks (the regional banks that make up the central bank). The FOMC is headed up by Powell. When the FOMC meets, it reviews economic conditions, determines the appropriate stance of monetary policy and assesses the risk of its long-run goals of price stability and sustainable economic growth. After the meeting, the chairman has a press conference to discuss the FOMC’s view on the economy and announce changes to monetary policy – usually by way of a change in interest rates.
On Wednesday, such a FOMC meeting occurred and Powell announced a 50-basis point (in total, 0.5%) increase in the federal funds rate at around 2:30 pm ET. I specifically mention the time because it is the main item I want to zoom in on this week. The picture of Powell’s face on the following charts marks the start of his press conference. The charts span a period of two days, Wednesday to Thursday.
The U.S. Dollar:
The Nasdaq 100:
The 10-Year U.S. Treasury yield:
The S&P 500:
At around 2:30 p.m. ET, all of these markets reacted. Bitcoin, Nasdaq 100, S&P 500 and gold went up; the 10-year yield and the U.S. dollar went down. Less than 24 hours later, all of these moves reversed as if nothing had happened. And then they kept reversing (bitcoin got wrecked on Thursday). It was almost as if Powell issued a statement saying, “Psych!” and reneged on everything he said at the press conference.
The markets react
Before we go further, what did Powell tell us and what should have happened? Powell’s comments shouldn’t have been positive for risky assets like stocks – full stop. Rates going up, inflation catching economists by surprise and a contraction in the country’s gross domestic product in the first quarter don’t exactly scream, “Wow, the economy is doing great – more risk please!”
Powell and the Fed also seemed to have replaced “inflation is transitory” with “we will have a soft landing.” That basically means the Fed thinks, “Okay, inflation is high, but we will get this under control without going full Volcker.” Full Volcker refers to how former Fed Chairman Paul Volcker cut inflation from 15% to 3% between 1980 and 1983 by jacking interest rates up to 20% – which would have been great if there wasn’t also a recession at the time.
OK, but markets did eventually reverse and do what was expected of them. Does that matter? I think it does. Here’s why.
First, it gives further credence to the point I made three newsletters ago about narrative driving market moves. I admittedly stole that idea from Benjamin Graham, the spiritual father to both value investing and Warren Buffett. Graham used Mr. Market as an allegory in his book “The Intelligent Investor” to describe the irrationality of the stock market and groupthink.
Markets (especially in the short term) are narrative driven because of Mr. Market. On Wednesday, Mr. Market thought that a 50-basis point interest rate hike wasn’t bad and ignored that inflation was high and GDP contracted. The very next day, Mr. Market said, “Oh wait, that inflation was kind of high. I'm scared of inflation now.” Cue the market reversal.
Second (and I admit this might be alarmist of me, but whatever), this highlights the dangers of a highly connected, information-rich world where high-frequency trading and quantitative firms scrape the internet for clues on how to trade everything. And these firms can react to news faster than anyone. And sometimes they can react “incorrectly.” And now even Mr. Market can react quickly. One of the FOMC’s stated goals is “price stability,” and even though that price stability goal is about goods and services, volatility in markets is also destabilizing. It probably goes without saying (but I’ll say it anyway): Instability is usually not good.
Lastly, and this is really my main point, the market is kind of … uh … absurd? I don’t know. At the very least, it’s too reactionary to ever take it seriously at face value. The market keeps crying wolf. Any time the market reacts to news, we should all collectively take a breath and really think about what the news means.
With that, I urge you again: Zoom out. Think longer.