The February stock market couldn’t find its way to the front page of the March 1st edition of The Wall Street Journal having to settle for a headline on the front of that day’s Business & Finance section “Nasdaq Notches a Record Close”. Barrons, choosing to deflate talk about lighter than air objects, headlined “The Stock Market Looks Like a Bubble. What Is It Really?” Perhaps the publication was mocking that week’s Economist’s cover of a bull being lifted airborne by a bouquet of balloons though livestock’s 12% rise in prices is one of the few assets to outperform the S&P 500’s two month return of 7.1%, its best start to a year since 2019 with 5.3% of that total coming in February. Most investors would welcome signs of inflation in their portfolio returns but with 60/40 portfolios still down 5.7% over three years many investors are not only not airborne but actually underwater.
A year ago, 99% of economic forecasters were predicting a recession in 2023. Of course, in the contrarian nature of such things, the inflation adjusted rate of growth last year was 3.10%, above its 2.20% average annual rate of growth in the prior ten years. Properly chastened, 76% of the forecasting fraternity believe the possibility of a recession this year is 50% or less. Of course, the opinion that matters most, that of the Federal Reserve, is either more nuanced or, if you prefer, confused. While expecting a 50% reduction in the US economic growth rate this year to 1.5% and with it expecting inflation to decline further to 2.4% the Fed’s chairman has also stated publicly “…we have a strong economy. The labor market is strong…with the economy strong like that, we feel that we can approach the question of when to begin to reduce interest rates carefully.” Careful may be the chairman’s view of his approach to matters but the previous two times this century the Fed had its Funds Rate at a level more than 2% above the rate of inflation was 2001 and 2007 and our experience of the economy in the following year was, shall we say, interesting.
Four numbers, -0.38%, -0.64%, +1.93% and 3.1%. The first is M2, the most commonly used measure of money in our economy. It is declining. The second is the extension of credit by the US commercial banking system. It is also declining. The third number, the actual value of loans and leases extended by our banking system, is positive but it is less than the fourth number, 3.1%, which is the most recent year-over-year rise in the consumer price index aka inflation. Small business depends upon the banking system to extend credit and that supply of credit is declining. As the source of 50% of the jobs and 43.5% of our economy how can small business be expected to grow in a declining credit environment and how can the US economy be expected to grow if half of it isn’t?
Could our nation’s central bank profess to doing one thing while preparing to do something else? Certainly, no certainty here but just supposing. The Fed, responding to the inflation resulting from the federal government’s public policy response to the pandemic, began raising its Fed Fund’s Rate in March 2022 with its final increase occurring in July of 2023. The inflation and those higher interest rates resulted in the market value of outstanding US Treasury debt declining by 31%. (Lower bond prices are the source of negative portfolio returns these past three years.) Now for a little history. Prior to the Global Financial Crisis commercial banks held very little in reserves at the Federal Reserves. After it the Fed adopted an “ample reserves” policy and commercial banks now hold $3.5 TRILLION at the Fed for which they are earning 5.4% and which is costing the Fed close to $200 billion in interest payments per year. From October 1, 2023, through January 31, 2024, the US Treasury issued $9.6 trillion in new debt, 92% of which was used to provide the necessary funds to pay off its maturing debt. The public currently holds $27 trillion of US Treasury debt, 16 ½% in Treasury bonds with an average interest rate of 3.1%, 52 ¼% in Treasury notes with an interest rate average of 2.3% and almost 22% in Treasury bills with an interest rate of 5.4% and maturity dates of up to one year.
The US Treasury is now paying $870 billion on its debt exceeding the $822 billion defense budget. What if the Fed were to lower interest rates to say 3%, stop paying interest on commercial bank reserves forcing much of that $3.5 trillion into the US Treasury bill market allowing it to notably lower its interest payments on those securities while having something left over to buy up some of that treasury debt now trading at 69 cents on the dollar? Perhaps that equity bull might be looking for something with a bit more of a charge in it than lighter than air balloons!
Over the span of a year, it continues to look like the S&P 500 starring as Snow White with almost everything else looking like dwarfs. Roughly stated, “the 500” is +30% with mid-cap stocks up half that much, foreign developed markets looking like mid-caps, small caps up half as much as mid-caps and foreign emerging markets splitting the difference between small and mid. Dare one say it? Mid-caps outperformed “the 500” in February and it is starting to “feel” like a party to which more are invited. In February 60/40 portfolios returned 2.9% and are now +4.5% year to date with equities contributing 4.6% to February’s return and fixed income 1.6%.
March 3, 2024/Mark H Tekamp
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