Exclusive Insights Report, New York, NY ~ We have a non-consensus call on the stock market for 2024 with a 5,500 target with the greatest risk to the upside. We have called the economy and market better than most strategists since the Fed’s QT intervention in 2020. We have listed below 10 myths or misconceptions about the economy and stocks that we believe caused both the Fed and strategists to miscall inflation and the stock market during the Pandemic and continues to make most strategists too bearish about 2024.
Myth 1: The Money Supply Does Not Matter:
Chair Powell has said publicly that money supply growth is not a relevant economic indicator. In fact, changes in the money supply are 66% correlated with inflation.
The quantity theory of money is relevant particularly when there are enormous swings in the money supply such as the Feds' 66% increase in the money supply in the first year of the Pandemic. The chances of having no significant increase in inflation after a 66% increase is zero otherwise modern monetary theory would hold.
Myth 2: Inflation is “sticky” and can spontaneously re-ignite if the Fed is not vigilant.
The Fed’s Arthur Burns caused inflation to reignite by not being sufficiently restrictive during the 74/75 tightening. Paul Volker was a hero by “stamping out inflation”.
In fact, 90% of the inflation of the 70’s was caused by an unimaginable 1,200% increase in the price of oil driven by two conflicts in the Middle East. There is at least a 5% bleed-through of energy prices to the core as every business consumes energy.
The crisis was worsened significantly by disastrous US Energy Price controls which set US-produced oil prices 75% below the world price and caused US production to drop from 10MM BBL/Day to 8MM BBL per day.
After the US deregulated oil prices in 1980, there was a global expansion of non-OPEC oil production, including the US, and a 66% drop in the price of oil causing a period of declining inflation.
Myth 3: The labor market is the primary driver of inflation and can lead to a “wage/price spiral” (The Fed’s Phillips Curve theory of Inflation).
Wages are sticky and slowly rise in response to rapid increases in goods prices/rents. Real wages declined by 6% during the 70’s and 3% during the Pandemic inflation as nominal wage increases lagged price increases. The US is now only 6% unionized. Nominal wages are dependent on increases in goods prices and real wage increases are driven by incremental investment.
Myth 4: The consumer is fragile and can spontaneously combust leading to a recession.
In fact, there has never been a significant US recession since WWII that was not precipitated by a plunge in the housing sector. Investment spending is the primary driver of GDP fluctuations as it is far more volatile than consumer spending even though it represents only 20% of US GDP vs. consumer spending at 66%.
Myth 5: Corporate earnings growth is dependent on margin expansion and/or high nominal GDP growth.
More than 100% of earnings growth is driven by the re-investment of retained earnings, depreciation, and R&D expenditures. If businesses do not continue to invest, earnings will stagnate and eventually decline.
Normal US earnings growth is approximately 10% which is driven by a 70% earnings retention and a 15% after-tax return on investment.
Historical stock price returns are close to 10% and driven almost exclusively by earnings growth.
Myth 6: US long-term interest rates are solely determined by US monetary and fiscal policy.
The global sovereign bond markets are mostly fungible and more than 80% correlated.
The rapid rise in interest rates in July-October was triggered by a sharp drop in the Global Monetary Base as the ECB reduced its money supply by $700 billion in a week.
Myth 7: QT is independent of rate policy and can lead to additional restraint on the economy.
Rate policy is nearly 100% correlated with increases/decreases in the Fed’s balance sheet as the Fed must restrict the money supply to effectuate the rate increase.
Almost no one appreciates that the Fed was forced to offset all of QE in 2021 as rates would have gone below zero and the Fed has offset more than all of the impact of QT in 2023 to keep rates from exceeding its rate target.
Myth 8: Tech overvaluation is inefficient and can lead to dangerous bubbles.
Overvaluation of companies in promising growth sectors makes the US capital market the most efficient in the world.
For emerging technologies, time to market is more important than efficiency to get to market. Standards and other first-mover advantages dominate.
Myth 9: The Stock market is like a casino where the odds are stacked against the investor.
The compounding of the reinvestment of retained earnings stacks the deck in the favor of the investor as earnings almost assuredly will grow if companies make prudent investments including potentially buying back stock.
Long-term investment in profitable companies at reasonable valuations is a reliable way to produce long-term attractive returns in the 10% area.
Myth 10: The Fed’s 2% inflation target was well thought out and has been a success.
In fact, the Fed’s 2% target was a result of global central bank groupthink and was arbitrarily established by the New Zealand central bank in the 70s.
The Fed’s 2% target has been a disaster as academic research shows that it significantly exacerbated the Great Recession and the low target has caused nominal wage growth to collapse, hammering the middle class.