Weekly eLetter 11/18/2022 – Is the Downtrend Intact?

Markets enjoyed noticeable buoyancy in recent days. Significant was a print on CPI, the ‘inflation’ data point, that was seen as a possible inflation downtrend indicator – which would translate into a probable uptrend for the markets. But then one is reminded that all that glitters is not gold.

St. Louis Fed President James Bullard on Thursday said he would defer to Chair Jerome Powell to decide on the size of upcoming rate increases as the Fed feels its way toward more restrictive monetary policy and an eventual stopping point. He added that ‘maybe the near-term target for rates is 5-7%’. Perhaps Mr. Bullard should have left it at that.

“On the question of how much to do at any particular meeting … I would leave that up to the chair,” Bullard said. “If you do more now you have less to do in the first quarter (of 2023). If you do less now, then you have more to do in the first quarter. Generally speaking, it probably does not make a lot of difference in terms of the macroeconomics.”

Now, I have to say that I think it is important to take a closer look at how Mr. Bullard arrived at his conclusions. According to the official St. Louis Fed website:

“Bullard used Taylor-type monetary policy rules to obtain recommendations for the value of the policy rate given current macroeconomic conditions. He noted that a Taylor-type policy rule with generous assumptions will give a minimal recommended value for the policy rate, while less generous assumptions will give an upper bound for a desirable target range for the policy rate. The recommended “zone” is the area between the two bounds”.

Now bear with me just a tad longer where The Devil, along with obscurity, seems to be in the details. Warning: some of what follows will probably be somewhat arcane to most of us who do not have a PhD in economics. That’s OK, you will still get the gist of Bullard’s thinking.

For the generous Taylor-type rule specification, Bullard used assumptions that tend to recommend a lower policy rate value. In particular, he used the Dallas Fed trimmed-mean personal consumption expenditures (PCE) inflation rate in the inflation gap measure, an approximate pre-pandemic value for R* of -50 basis points, and a relatively low value of 1.25 for the parameter describing the policymaker reaction to deviations of inflation from target. 

For the less generous specification, Bullard used core PCE inflation (which excludes food and energy prices), a higher value for R* of +50 basis points, and a value of 1.5 for the parameter describing the reaction of the policymaker to deviations of inflation from target. 

If you are a little confused by all of this, then you are quite likely in the company of 75% or more of the financial community and the pundits who comment on it. And why not? Mr. Bullard is obviously a really smart guy, but his calculations relied on assumptions piled upon other assumptions. There is another problem too; When a Fed governor gives an early morning talk there is little time between the talk and market open. Predictably, some folks will spring into action prematurely — based on what they think they heard. I think that happened Thursday morning. Some failed to wait to hear Bullard also say:

“…the recommended zone for the policy rate could decline. That zone could decline as new data arrive, particularly if inflation decreases in the months and quarters ahead, he noted, adding that market expectations are for declining inflation in 2023.

Caution is warranted, however, as both financial markets and the FOMC’s Summary of Economic Projections have been predicting declining inflation just around the corner for the past 18 months.”

(Source: https://www.stlouisfed.org/news-releases/2022/11/17/bullard-presents-getting-into-the-zone

This morning Boston Fed President (and CEO), Susan Collins also weighed in. She summarized one of her key points thusly:

“By raising rates, we are aiming to slow the economy and bring labor demand into better balance with supply. I remain optimistic that there is a pathway to re-establishing labor market balance with only a modest rise in the unemployment rate – while remaining realistic about the risks of a larger downturn.”

So, to our eyes and ears, Collins seems to have punted: The Fed is still looking for a rise in unemployment as key to dropping inflation. However, it could well be that any rise at all would give them justification to lower rates.

At any rate, it is clear that the Fed, having been accused of being late, now wants to avoid charges of too early to reverse.

Ron’s Market Minute — How Many Times Can a Man Turn His Head and Pretend that He Just Doesn’t See? 

Over the past several years, we have been invited to meetings, conferences and MANY zoom group-meetings sponsored by organizations promoting investments in cryptocurrencies of one sort or another. 

There has also been a plethora of ‘educational’ programs, to which we have also been invited. I and we have spent countless hours on background information attempting to make sense of the monstrous sources of literature that explain the ‘hows and whys’ and importantly the reasons why many within the investment management industry believed that crypto and blockchain offerings were a prudent place to direct investor’s funds. 

And it’s been rather difficult to admit that we just couldn’t make sense of why hedge funds, venture capital firms and some other professional investors (including the well-respected firms such as Sequoia Capital, Singapore’s state-owned investment company Temasek, the Ontario Teachers’ pension Plan, SoftBank Group) appeared to be realizing huge gains from their exposure to crypto-currencies, particularly those who had invested billions of dollars thru FTX, the cryptocurrency exchange. All of those firms had ‘due diligence’ departments that had supposedly looked at the viability of FTX from an investment viewpoint. Perhaps the lure of incredibly huge potential gains for clients caused some to turn their heads and not see the potential dangers. 

This past week one of the crypto organizations (FTX) turned a 32 billion dollar asset into a monstrous loss. I’ve heard that it was the greatest loss in one day in financial history. Perhaps. We can rest assured the Congress will eventually get around to trying to regulate that industry better. 

Crypto may well SOMEDAY transform the world, however perhaps in the same manner that Levi Strauss made a fortune selling jeans to gold miners in the 1840’s, and the way that the dot-com era spawned great investments in electronic infrastructure (remember that the actual dot com companies have mostly disappeared!) the crypto craze may be a place to look for infrastructure investments in the blockchain industry.

We had determined early on that IF we were to consider investments related to the crypto industry, we would need to be able to (probably) work with the technology that supported the industry. A cursory check this morning shows that the support industries are also down significantly more than the major indexes as of today (Year to date returns in the minus 60% area).

SO, first I’m indeed thankful that we spent so much time investigating the area (at the request of many clients), and second, wish I could have that time back.

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite D406A
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk


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