Milton Friedman, the conservative University of Chicago economist and Nobel Prize winner, started talking about long and variable lags in the late 1950s. He described that the process central banks follow to aid or retard economic activity by adjusting interest rates up or down is fraught with timing issues. When interest rates rise, they will eventually show their effect, but very little change occurs immediately.
Think of economic activity as a fully laden oil tanker, when the brakes are applied it takes miles and miles before the slow down to a standstill finally occurs. The knack therefore is not to brake too late or the tanker will run aground.
There is an emerging fear that central banks should have applied the brakes months ago.
We have watched valuations of our portfolios ebb and flow over summer in typical fashion. Veteran investors have experience of lower return summer months and higher return winter months. But suddenly September is back to haunt us once more as the month of the year which typically gives the lowest returns. This year it’s negative returns so far, taking our valuations down to the lowest point since April.
The US Federal Reserve has maintained the confidence of market participants so far as a delivery of a “Soft Landing” seemed to be achievable. In turn this soft landing was anticipated here in the UK and across Europe. Last October in “Have Interest Rates Peaked?” I said;
The real indicator for central banks is the level of unemployment. So far the rises have been low, but at some point the trickle picks up speed and then it positively floods higher if central banks send rates too high and put companies out of business. The level of un-employment itself is a lagging indicator. The numbers aren’t reported until it is too late and those individuals are placed on “the dole” or whatever it is called today.
Deeply flawed job creation numbers
In the UK we focus on the level of unemployment. In the US they place a positive spin on things and follow job creation numbers. Those US job totals have just been revised down considerably. It seems 818,000 new jobs created in the US just don’t exist following the revision. This would suggest the data the FED was relying on to bring about the soft landing were deeply flawed. The revision is the largest for over 15 years. Worse still it seems many of these new jobs created, and have since been removed, were registered by the Government. There is a question that there has been some deliberate manipulation to ensure the Biden administration entered the next presidential election with a strong economic record. Conspiracy theory or not, investor sentiment has been severely dampened. Hence the recent market setback.
Looking beyond the mainstream media comment, it is still possible to find a balanced view on the latest crowd upsetting revisions.
“160 million people have a job,” Slok said. ”Telling me that over the last 12 months it wasn’t 160 million, it was only 159.2 million is not making too much of a difference to how the Fed and financial markets are thinking about the economy.”
Torsten Slok, chief economist at Apollo Global Management
What’s Next?
All bull markets begin with setbacks, causing prices to fall. The bargain hunters awaken along with those who are cash heavy (like us) now expecting a falling return on our cash. The cash that was happy to sit it out on the sidelines eventually enters the market and brings with it an investment tail-wind. We have seasonality on our side and a usually good bonus period in the run in to the US Presidential Election.
The expectation is US rates could fall by 0.5% in September and a full 1% by the end of the year which will be a boost to companies and therefore equity values.
Next Blog
My next blog will detail my thoughts on the upcoming Labour Budget which “promises to be painful”.
I believe there will be action to be considered for each of the following clients
- Clients above the age of 55 who have not yet taken their full tax-free cash from their personal pensions.
- Individuals who are reliant on Business Relief to reduce the families final Inheritance Tax bill.
- Individuals who have large un-crystallised capital gains in General Accounts.
- Individuals who are relying on the additional Residential Nil Rate Band (£175,000) for Inheritance Tax purposes. I’m pretty sure this allowance will be removed.
- Pensioners whose assets total more than £325,000, when their savings, home and probably private pension are taken into account.
Charlie, Melissa and I know we are going to have a busy run up to 30th October and beyond. As always we are on hand to help all clients navigate this change of guard.