The month of April saw markets lose (8.8%) for S&P 500 while the Dow lost (4.9%) and the NASDAQ lost (13.3%).
I am a worried optimist – I say that because while I’m worried, I am also optimistic that we will not see the horrific economic challenges of the 1970s repeated.
Why am I optimistic? Because I understand why inflation has become an issue, I am optimistic that inflation will not spiral out of control as it did in the 1970s. The Central bank has a term, R-star – the interest rate that keeps supply exactly in line with demand. That number has risen in the post-pandemic world to what the Fed expects is about the 2.5% range, up from the 0.5% range. The Fed is being very clear that they are raising rates to this 2.5% range and then will monitor the economy to what effect higher rates are having. Another factor is that the stimulus was simply too large creating outsized demand. This outsized demand helped fan the flames of supply-side issues, most of which are well known. While the Fed cannot and should not fight the supply chain woes, there is a sort of mechanism that will eventually fix those problems. As inflation goes higher, more and more folks who did not want to return to the workforce, are returning. Some of those folks retired but now are afraid that inflation will erode their retirement savings. Some of those folks were short-sighted and were living off the stimulus and the benefits from the stimulus packages. Reality is setting in. Either way, more folks are returning to the workforce, which will help resolve supply chain issues. Innovation inefficiencies out of necessity are also helping to alleviate supply chain issues. In the Socratic dialogue ‘Republic’, Plato famously wrote: “our need will be the real creator” which was modified over time into the English proverb ‘Necessity is the mother of invention’.
Result – Fed raises interest rates to the point where growth slows, when growth slows sharply, accompanied by rising interest rates, financial markets volatility ensues. While painful at the moment, it is a necessary pill to swallow to avoid inflation infernos of the past such as we experienced in the late 1970s.
Check out my monthly MarketWatch blog at: http://wcmtexas.com/marketwatch
Have a question? Let me know! Email me at kcompton@wcmtexas.com.