Is the Cure Worse than the Disease?

Dear Clients and Friends,

 

The primary pursuit of medicine is to treat illness, and that entails a risk/reward trade off that takes copious training and mental preparedness to practice effectively.  Often, the ‘cure’ is not without risk, but many times the treatment risk has a much greater benefit than neglecting the illness.  But, every once in a while, the treatment is simply worse that doing nothing, and this is where the Title to this paper comes from.  The world of finance is analogous to medicine in that- Financial authorities (Federal Reserve and Treasury) have to weigh their policy risk with policy reward.  For example, low interest rates create an environment that allows consumers and governments to pile on more debt at lower costs, and this ignites spending and hopefully growth.  However, low interest rates tend to punish savers looking for low risk investments and it also can create bad decision making by those willing to use lots of debt to finance purchases.  This see-saw approach to managing the economy is evolving, and as it evolves the goals tend to change.  These changes can produce new and existential risks that the investor must be aware of.

 

I have written extensively about impending inflation over the past months, knowing that whenever there is a demand shock, followed by massive spending, the likely outcome will be inflation.  The supply chains that slowed to a crawl a year ago, are now being tested by greater demand than one would have predicted last year.  These supply issues are creating problems, but over time they will abate.  The amount of money production from both the Federal Reserve and Washington is having an amplified effect upon the supply constrained market and there is a cure for this- Higher interest rates and lower spending.  This is the ‘cure’ for the disease and it is not without risk.

 

Every time the Fed decides to become more restrictive and either taper their purchasing of assets or raise rates the market has a melt-down.  So, the investor should expect that as the Fed signals that they will begin their unwinding of emergency measures by normalizing Fed policy, the market will take this news and sell, driving down stock market levels.  This could easily produce a correction in my estimation.  In addition, as Washington wrestles with proposed spending cuts and possible taxation issues, I would expect the market to greet this news with additional selling.  These are ‘cures’ for inflation, but they create risks to the market.  Bear in mind that normalization is necessary, and a light correction could be warranted based upon the past 6 months of market performance.  However, these ‘cures’ will create anxiety in our markets, and that anxiety is almost always manifest as downward volatility.

 

One year ago, the country was grappling with a Covid Crises with a deep self-induced recession. Today the economy is literally firing on all cylinders, and corporate profits are popping to levels not seen in decades.  In addition, as the EU and India begin to cope with their Covid spikes, more global demand will come on line bending supply chains further in the coming months.  The stock market is at all-time highs and we are starting to see many locations roll back Covid related restrictions to pre-pandemic levels.  The population of Americans that have either gained immunity through natural means, (through infection), or vaccination, is approaching levels that some argue offer herd immunity; and caseloads and hospitalizations due to Covid are dropping precipitously.  But in the world of finance, there is never a moment of respite from the news, and now we can see some dark clouds forming on the horizon.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risks including loss of principal. No strategy assures success or protects against losses.

 

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

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