NEWS
What Happened Last Week
The Producer Price Index (PPI) rose 0.2% in October, which is an acceleration since September but still in line with general expectations.
Core PPI, which excludes volatile food and energy prices, has risen 3.1% as of October 2024. As of October 2023, prices had only risen 2.2% the previous year.
Elon Musk has been appointed to head up the newly created Department of Government Efficiency, with the goal of cutting $2 trillion out of the budget deficit.
Two big elements which affect inflation are rate of M2 money supply growth, which is still slightly above its 20-year trend line, and the velocity of money, which is below historical norms.
Investor sentiment is very moderate. About half expect a bull market and half expect a flat or bear market, according to the AAII Investor Sentiment Survey and Fear and Greed Index.
How I See It
If I had to name the number one fear among investors, I would say inflation.
Let’s review a lesson in behavioral finance.
There are two common biases at play right now among investors.
- Recency bias: the tendency to overemphasize the importance of recent experiences or the latest information we possess when estimating future events.
- Availability bias: the tendency to judge the likelihood of an event based on how easily we can recall similar events.
Think about it. How long have you heard the topic of inflation harped on? The last three years?
Inflation is not about to surprise the markets in any meaningful way.
Investors always try to fight the same battle that they fought last time. But the next bear market is extremely unlikely to be a result of high inflation. It’s just far too well-known and well-watched.
I actually think the threat to the next bear market is somewhat dependent on how fast the Fed cuts rates. Counter to common sentiment, I personally hope they slow down the frequency and magnitude of rate cuts.
They need to reserve that little power that they have in monetary policy for a time of need. Right now is not that time.
Inflation has accelerated somewhat, but looking at money supply growth and velocity of money appears to indicate that it’s not likely to accelerate to any meaningful or disruptive degree. Slower money velocity helps curb inflation. And money supply has meaningfully dropped since it peaked in 2022.
Cutting $2 trillion in government spending could potentially have a near-term negative effect on US GDP. After all, government spending is a factor in the GDP equation! But it also would likely have a counterbalancing effect that keeps money supply growth rate low, keeping future inflation low.
But these cuts are likely to be phased out over time, so that even if the deficit can be eliminated, it shouldn’t be happening all at once in the same year. Government employees who are cut loose are likely to be offered a generous severance package.
While such spending cuts could eventually cause a slowdown in the economy (think 2027 or later), the long-term benefits would not go unnoticed by the markets. And therefore, I don’t believe that it would spell a deep recession by itself. When executed in combination with lower taxes and fewer regulations, it’s even possible it has a canceling out effect and manages to keep the economy growing healthily in the midst of the restructuring.
Like any healthy change, sometimes there is a period of difficult sacrifices before the benefits are realized. In the long-run, if this restructuring proves successful, it could potentially solidify and reinforce America’s economic leadership across the world for decades to come.
We don’t know where the next bear market will come from, but what we do want is for the Federal Reserve to keep interest rates meaningfully above zero so that the economy can grow strong and accustomed to them. Then when the next economic crisis hits, they have the ability to reduce interest rates and give banks the profit incentive to lend and stimulate the economy.