Comments by "Supernova" (@MrSupernova111) on "The Plain Bagel"
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Good video on the theory and technical aspects of interest rate hikes. However, the rate hike is only part of the story and I would argue that the bigger factors affecting the economy, and as a result the markets, are inflation and the war in Ukraine.
My takes:
1) The most recent US CPI inflation rate was 8.5% far above the Fed's 2% target. Clearly, the Fed is already far behind the curve on this inflationary cycle and one thing you didn't discuss was the velocity of the rate hikes. Sure, if the Fed only increases rates by .25% at a time then the impact on the market will be less pronounced than if they increased rates at .50% or higher. But then, what happens if the Fed continues dragging its feet and inflation keeps rising?
2) The war in Ukraine is adding more inflationary pressure globally on food and energy prices. Central banks might not be able to mitigate inflation with traditional tools which might lead to a recessionary period regardless of what the central banks do. The question might not be whether we enter an economic downturn but whether we have a crash landing or a soft landing.
3) I believe much of the middle class is being squeezed financially as much as they can handle due to insanely high (overvalued?) housing costs and inflation. Let's face it, a large portion of middle class people can no longer afford to buy a house because housing costs over the past twenty years have far outpaced wages. This means that millions of middle class people are one emergency away from a financial catastrophe which could bring down the entire house of cards down similar to 2008. For perspective, there were 2.3 million foreclosures in 2008.
4) Let's not forget that part of the stock market's gains over the last few years, at least in the USA, are due to Trump's efforts to get re-elected. Remember that Trump passed one of the most comprehensive corporate tax breaks in decades and pressured the Fed to lower rates in 2019 because Trump is a "low interest rate guy." We could argue about how much influence these policies had on the market but its undeniable that they contributed to higher market valuations.
5) During the pandemic we saw governments dump trillions of dollars into the economy. The effect was that the (US) market doubled from 2020 to 2021. If that doesn't scream overvaluation then remember that during the pandemic consumer spending and commercial activity dropped dramatically. In fact, in the US we had two consecutive quarters with negative GDP growth. Some industries got decimated and who knows many many thousands of businesses closed their doors permanently. The Fed estimates that 200 thousand small businesses in the US closed permanently due to the pandemic but the real number likely much higher.
In conclusion, I think its very possible that we're sitting on the largest bubble we've experienced since at least 2008. It only takes one segment of the market to pull down the house of cards that the market is currently sitting on. In one scenario, perhaps, we don't have a full blown recession similar to 2008. However, I think its very likely that the (US) market is still very much overvalued and we will enter a recessionary period of some sort within the next 12 months. In pre pandemic 2020 the S&P 500 was at 3,380. Today, almost exactly two years later the S&P500 is at 4,400. This means that the stock market experienced a 33% gain in the middle of a pandemic while commercial activity and consumer spending took a massive nosedive. I would ask how is that possible but we already know the answer. Lastly, let's be honest, if the US goes into a recession we're likely to bring down much of the first world with us due to our global economic influence. We'll see where all this leads but I wouldn't be too optimistic about market performance over the next couple of years.
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